Should You Follow RadioShack's Move Higher?

After news broke that a bullish options trader had come into the fray, shares of RadioShack soared. Should investors follow suit or would Best Buy be a better pick?

Jun 9, 2014 at 10:00AM

Images

Source: Wikimedia Commons

One of last week's best retail stocks was one you might least expect: RadioShack (NYSE:RSHCQ). Even though shares of the electronics store chain are down 66% from their 52-week high, investors flocked to its stock after news surfaced of a trader placing a big bet on the business. In light of this recent development, should investors take this as a sign that the company is on the verge of a turnaround? If not, would Best Buy (NYSE:BBY) make for a more sensible play at this point?

RadioShack's big news
For the week ending May 30, shares of RadioShack soared 24% from $1.21 to $1.50. Most of this gain took place during the last two days of the week, with shares jumped 14% during this period. According to news reports by TheStreet, the reason why the company is rising relates to the revelation that a big trader has put a lot of money down in a speculative bet against how well the company's stock will perform over the next few months.

Picture

Source: RadioShack

In a nutshell, this unnamed trader bought 20,000 call options valued at $600,000. With a strike price of $1.50, the speculator is boldly claiming that the business's stock price will be trading above this level at some point between now and October. In the event that he or she is right, the payoff could be very large; if the company's stock is not trading above that price (plus the cost of the contracts), however, most or all of that money will be lost.

What does this mean for you?
The Fool prides itself in buying into a company's shares based on the idea that we can capture significant upside through Mr. Market realizing a business is undervalued. Sticking true to this philosophy means that buying short-term call options like this is questionable because they expire worthless after a while (if the company's stock does not rise enough) and because their value is not predicated on the business's fundamentals. Instead, the value of an option is mostly  based on the price the company's shares are trading at at a given time.

With that being said, if there is value to be found in a company like RadioShack, it would be a disservice to not assess its prospects as a viable long-term stock holding. Doing so however would point to a company that is facing severe challenges.

Over the past five years, RadioShack has been a grave disappointment to its shareholders. Between 2009 and 2013, the company saw its revenue drop nearly 16% from $4.1 billion to $3.4 billion as aggregate comparable store sales dropped 12% and the number of locations in operation decreased by 16% from 6,563 to 5,519.

RSH Revenue (Annual) Chart

RSH Revenue (Annual) data by YCharts

From a profitability perspective, the company's numbers have been even worse. With falling sales and stubbornly high costs, RadioShack's net income has plummeted from a gain of $205 million in 2009 to a loss of $400.2 million. The business's plight has been so bad lately, in fact, that management announced a plan in March to close as many as 1,100 underperforming stores. Much to the retailer's chagrin, however, management had to rescind on this decision due to its creditors allowing no more than 200 closings in a given year.

Over a similar five-year timeframe, rival Best Buy also experienced some poor results, but not to the same degree that RadioShack has. Between 2009 and 2013, Best Buy's revenue dropped 3% from $43.8 billion to $42.4 billion as an aggregate comparable-store sales decline of 7% was partially offset by a 26% jump in the number of locations in operation from 1,565 to 1,968.

RSH Net Income (Annual) Chart

RSH Net Income (Annual) data by YCharts

Looking at things from a profit perspective, on the other hand, leaves the situation for Best Buy not appearing very pretty either. During this five-year period, the electronics retailer saw its net income fall 60% from $1.3 billion to $532 million as lower sales were accompanied by soaring impairment charges, slightly higher interest expenses, and some losses from discontinued operations.

Foolish takeaway
Based on the data provided, it seems like Mr. Market is confident in this masked trader's bet. While it is possible that his or her options play will be successful (and I hope it is), investing in this way carries with it a lot of risk. For this reason, the Foolish investor should rely on the company's long-term performance and combine it with realistic expectations moving forward to determine if a stake in the firm's stock makes sense.

Using this approach, it's not too hard to guess that the 200 locations the company will close this year will be harmful to sales but beneficial to profits. Even if management can succeed in its goals to shutter some of its worst stores, though, the problem of falling sales and high costs make the company look pretty risky. This does not mean that a stake in RadioShack would be a bad decision, but it does suggest that Best Buy's bad (but much better) metrics could make it a more sensible prospect for further analysis.

Leaked: Apple's next smart device (warning, it may shock you)
While the picture isn't looking good for RadioShack, there is good news on the horizon that might help turn its fundamentals around; Apple's newest wearable device!

You see, Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

Daniel Jones has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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