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Stupid Dividend Recommendation of the Week

Shame on Forbes!

On Monday, the respectable financial publication sullied its reputation by syndicating shoddy advice from the Dividend Channel, trumpeting struggling electronics retailer, RadioShack (NYSE: RSH), under the headline, “This Stock Has A 12.14% Yield And Sells For Less Than Book.”

What’s so wrong about recommending a cheap stock with an above-average yield? In this case, everything! And here’s why…

Why Chasing Yield is Always a Bad Idea

Yield is always a function of price. The lower a stock falls, the higher its yield goes. But price is always a function of the underlying business.

So if a company’s fundamentally strong, and keeps increasing earnings, its share price will naturally head higher. Conversely, if a company’s fundamentally weak, marked by continually declining earnings, its share price will naturally head lower.

What’s my point? Well, if we’re evaluating a potential dividend stock, a double-digit yield should always be an immediate deterrent, not a come-on.

It’s a huge red flag that something’s wrong with the underlying business. And RadioShack proves my point wonderfully.

In the last year, the stock’s down 66.1%, pushing its yield from about 2% to 12%. But we can’t blame this on the market. Over the same period, the S&P 500 Index is up 8.4%. So, clearly, the collapsing stock price and soaring yield is symptomatic of a struggling business.

Of course, you don’t need me to tell you that RadioShack’s struggling. Just ask yourself, “When’s the last time I was in a RadioShack store?” Can’t remember, can you?

Neither can a large majority of consumers.

Whereas the average retail company enjoyed an average annual sales growth of 7.5% for the last three years, RadioShack posted an anemic 1.5% sales growth rate.

In terms of profitability, the picture’s even uglier.

The average retail company increased earnings by an average of 21.8% per year over the last three years. Yet RadioShack’s earnings are down an average of 23.8% per year over the same period, according to Morningstar.com data.

That statistic is particularly damning to Forbes because the Dividend Channel article boldly – and wrongly – touts RadioShack’s “favorable long-term multi-year growth rates in key fundamental data points.”

I don’t know about you, but 1.5% and -23.8% don’t exactly qualify as “favorable” in my book.

Of course, the earnings statistic is even more damning for RadioShack. In an industry where brick-and-mortar electronics retailers are a dying breed (think Circuit City), it appears to be next up for extinction.

I make that prediction based on the following facts:

  • In January, management canceled the $200 million stock repurchase program it instituted in late October 2011. Such a sudden reversal is not a sign of financial strength.
  • In the last quarter, comparable store sales dropped 4.2% year-over-year and the company swung to a loss of $8 million.

At the very least, RadioShack’s dividend is in jeopardy of being cut or eliminated altogether. This fact was revealed on a conference call in February, where CEO, James Gooch, conceded executives are reviewing the company’s dividend policy.

Bottom line: RadioShack sports a high yield and cheap valuation for a good reason. But look out, because before long, the only thing it might be sporting is a cheap valuation. Dividend investors beware!

Ahead of the tape,

Louis Basenese