Just over a month ago, I lambasted Forbes for syndicating an article endorsing struggling electronics retailer, RadioShack (NYSE: RSH), as an attractive dividend investment.
I specifically warned, “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.”
Instead of broadcasting an obnoxious, “I told you so,” let’s just say RadioShack’s cheap valuation now stands alone…
Yesterday, shares plummeted 28.7% to hit an all-time low. What happened? Well, the company reported a second-quarter loss of $21 million, or $0.21 per share, its deepest quarterly loss since 1996.
That’s bad enough on its own. But it’s even worse when you consider analysts expected the company to eke out a small profit of $0.03 per share.
Worse still, management suspended the company’s dividend payment to address a liquidity crunch. You’ll recall that last month I wrote, “RadioShack’s dividend is in jeopardy of being cut or eliminated.” I didn’t think it would come to pass so quickly, though. But that’s beside the point.
The real story here is this: Any investors that bought shares a few weeks ago expecting to collect a fat 12.14% yield are instead nursing a fat lip and a fat loss. Or more simply, this is just another painful reminder of why we should never chase yield.
It’s a huge red flag that something’s wrong with the underlying business. There’s no room for arguing that point when it comes to RadioShack.
Over the last year, shares started collapsing under the weight of increasingly poor results, not a general market selloff. The lower stock price, of course, pushed the yield higher.
Instead of making income investors salivate, though, charts like this should make them run away.
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If you’re one of the unlucky shareholders that owned RadioShack before yesterday, please don’t hold on to shares. Hoping management will someday reinstitute the dividend and propel shares on a miraculous recovery is a pipe dream.
That’s not going to happen. Consider:
- The company’s reported a loss for two consecutive quarters (and counting).
- Profitability’s eroding. Margins contracted eight percentage points to 37.8% in the most recent quarter.
- The company’s saddled with a hefty overall debt burden of $679 million, compared to a market cap of just $259 million.
- Fitch Ratings downgraded the company’s credit rating to CCC, which means RadioShack is vulnerable to a default. Or as Fitch said in a statement, “There is a lack of stability in the business and no apparent catalyst to stabilize or improve operations.” Yikes!
In other words, RadioShack’s stock is cheap for all the right reasons. The fundamentals stink and show no signs of ever improving.
Forget a miraculous recovery, the next stop for RadioShack is the courthouse steps. And savvy bond investors increasingly think so, too. All we have to do is look at the latest credit default swap prices for RadioShack.
They just jumped to a record 37.3% up front, according to data provider CMA. That means the cost to protect $10 million of RadioShack’s debt is $3.73 million upfront (last week it was $3.25 million) and $500,000 annually for five years. In comparison, the cost to protect against defaults by other speculative-grade companies are falling, not rising.
Bottom Line: Successful dividend investing isn’t just about finding safe, above-average yielding investments. It’s about avoiding stupid investments, too.
Just like we did with RadioShack, we’ll try to warn you about these potential wealth destroyers well in advance. So stayed tuned for the next installment of “Stupid Dividend Investment Recommendations.”