A Terrible Stock and Why I'm Holding Onto It

Sunday night, Kyle Chandler won an Emmy for outstanding lead actor in his role as coach Eric Taylor on Friday Night Lights. Don't be fooled by the title; the show isn't about football. It's about community, and it's absolutely outstanding. If FNL were a stock, I'd own it.

And yet, since its inception, FNL has been underappreciated and misunderstood. In fact, wildly popular ESPN.com columnist Bill Simmons had to take to his bully pulpit in 2007 to help save the show from cancellation.

What's this have to do with investing?
When you have a great product that doesn't seem to gain any traction with consumers, there's one target that's always in the crosshairs: management.

I won't get into the details of how NBC seriously mismanaged FNL; instead, I want to talk about another company with an outstanding product that management is absolutely wasting: Rosetta Stone (NYSE: RST  ) .

Se habla Espanol?
One year ago, my wife and I decided to move to Costa Rica for six months. In order to prepare, we bought all five levels of Rosetta Stone's Latin American Spanish. I'm happy to say that after having used the product, and having seen others try a smorgasbord of other options to lesser success, we are fully convinced that the product -- and its immersion technique -- was well worth the money.

We aren't alone, either; founding Fool David Gardner picked Rosetta Stone for his Stock Advisor service 19 months ago. Although Rosetta competes against CBS' (NYSE: CBS  ) Pimsleur, Disney's (NYSE: DIS  ) Publishing Worldwide, and McGraw-Hill (NYSE: MHP  ) , David saw Rosetta as a Coke with no viable Pepsi.

Management nightmares
Things started crumbling when Rosetta lost two C-Level executives in the course of just two months in 2010, and things continued to get worse from there.

A major snafu by the company's marketing executives led to far fewer ads in late 2010 than years past. At the time, CEO Tom Adams said the marketing woes, not weak U.S. consumer demand, were the reason for slow sales.

But by March 2011, Adams was changing his tune, saying that Rosetta Stone wasn't for most U.S. consumers, whom he termed language-learning dabblers.

Missed opportunities galore
As much as Adams' reversal irks me, it's the lack of forward thinking that has really gotten under my skin.

Consider: The company still has kiosks that sell the discs in airports and malls, instead of having transitioned to a subscription model where the software is cloud-based. Netflix wrote the blueprint for this years ago, but apparently there wasn't much creative thinking happening behind closed doors at Rosetta.

Also consider: The current price point is still very high (we paid $600 for all five levels). Even if done semi-regularly, it takes a long time to complete all five levels. A simple $30 per month subscription fee would lock in customers and probably bring in more revenue over time.

One more point to consider: The company's recent guidance for a loss in institutional revenue is completely unacceptable. As a former teacher, I can say with a degree of conviction that Rosetta is squandering an enormous opportunity in K-12 education.

We have a serious shortage of foreign language teachers in the U.S., and some schools are cutting their programs because they can't afford them. In most instances, a school's subscription to Rosetta costs far less than the salary and benefits of a teacher.

If education companies like Corinthian Colleges (Nasdaq: COCO  ) can somehow find a way to turn a profit when they get almost 90% of their money from the federal government, and almost 40% of its students default on their loans, there's absolutely no reason that Rosetta's products shouldn't be in many more American classrooms.

So why am I even holding?
Sometimes, even when your thesis turns out to be false, you still end up making money. I'm not saying that's guaranteed to be the case with Rosetta, but its growth in international sales, which are up 75% over the past 12 months, could end up being a huge boon for the company.

Right now, international consumers make up just over 20% of Rosetta's revenue. But that number will continue to grow as the company focuses on -- as Adams likes to say -- consumers for which learning a new language means bread, not cake.

Emerging markets represent a huge opportunity, and this is the one area where the company has not skipped a beat. As it makes up just about 2% of my portfolio now, I'm willing to hold to see how things turn out.

More ideas
If after my article, you find yourself excited about Rosetta Stone, I encourage you to dig a little deeper into its international potential, which could be a gold mine. If, however, you find yourself wanting a few more ideas, I encourage you to check out The Motley Fool's latest special free report: "The Hottest IPO of 2011." Inside, you'll get details of a company that could produce returns similar to those you would have gotten if you had invested in McDonald's circa 1971. The report is yours today, absolutely free!

Fool contributor Brian Stoffel owns shares of Coca-Cola, Rosetta Stone, and Netflix. You can follow him on Twitter at @TMFStoffel. He can't wait to watch season four of Friday Night Lights. The Motley Fool owns shares of Coca-Cola, Rosetta Stone, and PepsiCo. Motley Fool newsletter services have recommended buying shares of McDonald's, PepsiCo, Rosetta Stone, Walt Disney, Netflix, and Coca-Cola, creating a diagonal call position in PepsiCo, and buying puts in Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Read/Post Comments (9) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 23, 2011, at 9:33 AM, XMFTheGuruEbby wrote:

    Another reason to join the Army: free use of Rosetta Stone! Just kidding.

    Great article, Brian!

    TMFGuruEbby

  • Report this Comment On September 23, 2011, at 7:06 PM, Seti30 wrote:

    RST another Horrible pick from you, like NXPI...

    This is why I didnt renew your suscription

  • Report this Comment On September 23, 2011, at 8:20 PM, thejatrain wrote:

    I hope so...spoke with someone who interviewed at RST recently and it sounds like it's a friggin mess over there. I wonder of MF is a fan simply because they are also based in Northern Va....? This stock has put the hurt on me...

  • Report this Comment On September 26, 2011, at 10:20 AM, TMFCheesehead wrote:

    @thejatrain-

    Care to share details from your friend's interview? I'm always open to hearing new data.

    Brian Stoffel

  • Report this Comment On September 26, 2011, at 12:28 PM, thejatrain wrote:

    No details, the conversation was several months ago...but, as a shareholder, the information was not favorable....

  • Report this Comment On September 26, 2011, at 8:12 PM, manolosalceda wrote:

    Long term people! The company has a great moat on the foundation of a great product/service. They will transition to the internet, they don't have an option. I'm a shareholder who's taking advantage of current prices. If you liked it at $14 you should love it at $9.

  • Report this Comment On September 29, 2011, at 1:39 PM, devron50 wrote:

    As a nearly five year employee who left the company in June, I would urge you to reconsider holding this stock. In the past few days they have lost their International division president, and she was there for less than 1 year as I recall.

    RS had made huge inroads into the institutional marketplace in this country before it went public after releasing version 3. However, much of that business was squandered because the company does not test the product sufficiently before releases. I can't tell you how many times the student data was simply lost, both in the cd version as well as online.

    You are absolutely right about management. It's the single worst company I've ever worked for.

  • Report this Comment On October 03, 2011, at 11:08 PM, goldminingXpert wrote:

    Not sure what holding out is going to get you. That said, we are drawing close to my price target around $8. Not sure it bounces though when we get there.

  • Report this Comment On October 25, 2011, at 6:37 PM, thejatrain wrote:

    My sister's ex said the following about MCI: "Hey, if you liked it at $80, you love it at $50, right?"

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