Circuit City Will Burn Your Portfolio

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Avoid the need to hose down your holdings! Read our special series on stocks that will burn your portfolio.

Full disclosure: I'm no oracle, so I can't say with any certainty that Circuit City (NYSE: CC) will "burn" your portfolio. However, if the past is prologue for the future, shareholders might be just as well taking a match to their money. To date, Circuit City has burned through shareholder wealth at an alarming rate. Worse, that rate has increased over time, as the following table shows:

Period	Circuit City Share Price Annualized Return	S&P 500 Annualized Return
20 years	(1%)	7.9%
10 years	(18.1%)	0.9%
5 years	(24.9%)	4.5%

Source: Yahoo! Finance.

Retail is no place to be No. 2
First, a general argument against owning Circuit City shares. Retailing is a very tough industry: It's seasonal, requires the ability to manage substantial inventory, and is brutally competitive. Finally, it's very difficult for a retailer to differentiate itself other than on price -- which doesn't make for great margins.

Given those characteristics, it may well be that there is only room for one outstanding, dominant company in any one retailing segment. The following table suggests that front-runner grabs a "winner-take-all" position (or "winner-take-most," anyway).

Segment	Front-runner (CAPS Rating)	Also-ran(s) (CAPS Rating)
Books	Barnes & Noble (2 stars)	Borders Group (2 stars)
Drugstores	Walgreen (5 stars), CVS Caremark (5 stars)	Rite-Aid (2 stars)
Auto Parts	AutoZone (3 stars)	Advance Auto Parts (4 stars)
Office Supplies	Staples (Nasdaq: SPLS) (4 stars)	OfficeMax (1 star), Office Depot (3 stars)
Superstores	Wal-Mart (NYSE: WMT) (3 stars)	Sears Holdings (Nasdaq: SHLD) (2 stars)
Warehouse Clubs	Costco (Nasdaq: COST) (four stars)	BJ's Wholesale Club (3 stars)

I'll grant you that the "winner-take-all" model isn't perfect, but I think it's a useful way to think about retail. In consumer electronics, the front-runner isn't Circuit City, it's Best Buy (NYSE: BBY)

Why I don't want to bet on a Circuit City turnaround
If you already own Circuit City stock, this may be a case in which you don't want to leave with the date you brought to the dance. Retailers can and do go bankrupt from time to time (clothing retailer Steve and Barry's filed for bankruptcy this month, and Mervyn's is expected to do the same within the next few days); when they do, shareholders can expect to be wiped out. I'm not saying that Circuit City is in that kind of dire position (yet), but the outcome cannot be excluded over the medium- to long-term unless radical changes are made.

Can Circuit City survive, and even thrive? The answer is yes, but probably not in its current form. I think its best chance for success is to shrink the business dramatically, keeping only its best locations, and develop a strategy to clearly differentiate itself by focusing on a limited number of product categories, for example. I don't see evidence that the current leadership is ready to make those choices.

This is no time to own a troubled retailer
On top of it all, this simply isn't a good period in which to own a troubled retailer and bank on a turnaround. I'm no Cassandra when it comes to the state of the economy, but it is clear that consumer confidence is weak and there are signs that the rot from the credit bubble may be spreading to prime (and even super-prime) borrowers.

I've heard the tired saw about never betting against the American consumer before; even if we were to take this for gospel, surely now isn't the time to bet on them (not with respect to their ability to "bail out" a firm like Circuit City, in any event). I do, however, think there are interesting opportunities in retail among the best-run companies.

To add to Circuit City's woes, a difficult economic environment usually favors the best retailers, who are able to take market share from lagging competitors. Best Buy has been doing just that during the downturn, and I don't expect that to reverse itself anytime soon.

If I've done enough to convince you that Circuit City looks set to underperform the market, go over to Motley Fool CAPS and slap the stock with an "Underperform" rating. If you think my arguments are carpaccio-thin, be my guest and voice a contrary opinion with an "Outperform," instead. Here is my advance bribe for doing so: a stock that I believe will outperform over the next three to five years.

I don't like Circuit City, but here's a stock I do like
I recommended IT services firm SAIC (NYSE: SAI) in the March 2007 issue of Motley Fool Inside Value. I admit the stock hasn't done much since then, but it has proved itself exceptionally stable in a very volatile market (for the finance geeks, SAIC's stock beta is a super-low 0.56!).

Does SAIC's stock offer an extreme buying opportunity right now? I wouldn't go that far, but it looks like a very attractive, very safe play in this market.

Related Foolishness:

• Blockbuster Snubs Circuit City
• Circuit City Goes Haywire
• A Short-Circuit at Blockbuster