7 Signs You Own A Terrible Investment

posted on 06-07-2019

It's hard to see how an all-American company that's been in business for nearly a century could have fallen so far.

I'm not talking about J.C. Penny, Best Buy or any of those big box stores that have been struggling recently.

I'm talking about a company that started in Brooklyn as a single-store operation in 1921 by two brothers that made a business out of selling amateur, ham radio parts. Over the next nine decades, the company would expand into more electronics, but would face bouts of bankruptcy scares, massive layoffs and thousands of store closings all along the way.

Despite its struggles, the niche electronic firm managed to open 5,200 locations in the United States over its 93 year history. But as of recently, it appears its luck may be about to run out.

In case you haven't guessed by now, I'm referring to RadioShack (NYSE: RSH).

The company announced earlier this month that RadioShack may soon need to file for bankruptcy protection after filing its 10th quarterly loss in a row. Management said same-store sales dropped 20% in the latest quarter. Even worse, total sales at Radio Shack have plummeted to their lowest levels in 20 years.

Our resident expert in finding the world's greatest businesses, or what we call "Forever Stocks," Dave Forest, saw the signs of RadioShack's impending bankruptcy back in the March issue of his premium newsletter, Top 10 Stocks.

Dave even dubbed the company "The World's Worst Business" based on how it's been operating.

As Dave said roughly half a year ago:

"Successful firms carve dominant niches that make it clear to investors exactly what they can expect from these businesses, and why they should be excited about them as investments.

Firms that don't follow this mantra struggle.

I can't think of a better example than RadioShack (NYSE: RSH) -- a firm that's collapsing before the eyes of investors, despite being a once-hallowed name across the United States.

The retail firm reported fourth-quarter and year-end earnings earlier this month. And the results were ugly.

RadioShack's fourth-quarter loss widened to more than $190 million -- greater than triple the loss of $63 million the company reported for the same period of 2012.

The stock plummeted 17% on the news. But what's more telling is, as the chart below shows, RadioShack's investors have suffered a near-complete wipeout over the past four years, with the stock declining 90% since early 2010.

The future isn't looking any better. RadioShack announced it will close up to 1,100 stores across the United States -- over 20% of its stores. All of this has analysts predicting bankruptcy and the potential demise of the company.

The biggest problem is a basic one... If I asked you to define this business in a few words, what would you say? I struggle to think of... well, anything. Electronics? Tech stuff? A big R in a circle?

There simply aren't any distinct and defined qualities that make RadioShack unique. It doesn't have the selection of Best Buy (NYSE: BBY), the cool factor of the Apple Store, or the low prices of Wal-Mart. Consumers don't know what they should think of the store -- and so they're wandering away."

Fast forward six months to today, and RadioShack is even worse off. Since Dave's writing, shares of the stock have plummeted nearly 60%, and are now worth a piddling $0.80 each. Just imagine if you had bought shares when they were $24 back in early 2010... ouch.

The bottom line is, the problems that plague the "world's worst business" today are nearly the same ones that have plagued it for years. Fortunately, as Dave pointed out in his issue, there are several valuable lessons we can learn from RadioShack's poor business model. As he explained:

"RadioShack's lack of a defining 'theme' shows how not to build a successful firm. The takeways are especially apparent when we run the company through the list of qualities I use to look for great businesses in Top 10 Stocks. (We only buy what we consider to be some of the world's best-run businesses.)

Consider the following points:

The world's greatest businesses sell their products at premium prices.

RadioShack has actually been trying this strategy -- attempting to increase its margins to improve profits. The problem is that consumers need a justification for paying premium prices. An iPhone is more exciting than an LG Optimus. Coke (NYSE: KO) is more loved than Mr. PiBB. There's something more special about a diamond in a Tiffany (NYSE: TIF) box than a diamond from J.C. Penny (NYSE: JCP). RadioShack is... none of the above.

The world's greatest businesses sell products used in day-to-day life. RadioShack has been moving opposite to this rule -- looking to sell more complex and obscure private-brand products. The less simple your product becomes, the tougher your business execution gets.

The world's greatest businesses have a global reach and appeal for their product. Anyone who's been to Tokyo's giant Akihabara electronics district knows that RadioShack will never have global reach. Most countries have their own retail electronics businesses -- many of them extremely advanced. To be truly global, a business must offer a completely new experience, unavailable in the homeland -- the way a firm like Starbucks (Nasdaq: SBUX) does.

The world's greatest businesses have unlimited growth potential. It's hard to add new products or revenue streams to your business when customers are increasingly avoiding your existing lines. Once you lose consumer eyeballs, you've lost much of your ability to move in new directions.

The world's greatest businesses have clear competitive advantages that dominate their competition. This one is a complete bust for RadioShack. Name any aspect of retail and there's a competing firm that does it better. RadioShack isn't the cheapest, hippest, or most wide-reaching. It's struggling to catch up everywhere.

The world's greatest businesses generate enormous cash flow with low capital spending requirements. As mentioned, RadioShack has been trying to turn things around by adding new products to its stores. But every new product means a completely new purchase of inventory -- at significant expense. This is even more risky when you're dealing with unproven new products. RadioShack could end up with a lot of capital spending and little in the way of sales.

The world's greatest businesses have extremely high profit margins, or at least margins that outpace its broader industry. This is tough to do when you can't charge premium prices. RadioShack lacks the scale of a competitor like Best Buy that would allow it to drive down inventory and distribution costs in order to improve margins."

As Dave explained, there are plenty of red flags that all investors should be looking for when scouting potential investments in retail businesses or elsewhere. Dave gives readers a parting word of advice from this cautionary tale:

"I believe this also reinforces one of the core beliefs of Top 10 Stocks -- that the world's best investments hold simple yet fundamental things in common. These drivers of success come down to philosophy rather than financials.

By looking for firms doing these 'little things' right, you can pick investments that will generate value for years to come -- and avoid those that destroy shareholder wealth."

So far, Dave and his Top 10 Stocks team have seen excellent results over the past few years by following this strategy.

In fact, out of the 16 holdings in his Top 10 Stocks portfolio, 14 have been profitable and more than half are up over 18% since they were recommended. Some of his picks have even gained 53%, 73% or even 92% in fewer than three years -- and that's on top of the 4%-plus dividend yields they're paying right now. Dave talks about a few of these market-dominating companies in his latest research, which you can view here.

This article orginially appeared on StreetAuthority.com: 7 Signs You Own A Terrible Investment