The High Price of Cheap Stocks

RadioShack's shares looked cheap right up until they weren't. Should investors dumpster dive for RadioShack or invest in quality like Wal-Mart?

Jul 17, 2014 at 1:00PM

RadioShack (NYSE:RSHCQ) got its start as a nerd's paradise. Every kind of cable, widget, tube, model or gadget you wanted, they had it. Here we are in 2014, and many of the world's most successful companies are tech companies like Facebook and Google -- nerds rule. But what about RadioShack?

Amid the tech ascendancy, RadioShack has cratered.When your customers are tech-savvy nerds (I mean that as a compliment by the way), they are even more likely to buy online. That spells trouble for RadioShack.

Beyond the qualitative factors that govern the success and failure of business models, there is another lesson for investors on the quantitative side -- metrics that imply cheap prices can mislead. Compared to the S&P 500's P/E ratio, RadioShack's P/E has looked like a bargain. Who doesn't like buying dollar bills for $0.50?

Unfortunately for RadioShack shareholders, they may have paid $0.50 but they did not get back a dollar bill -- instead they may have bought a quarter's worth of value. Have a look at the relationship between RadioShack's P/E ratio versus its price.

RSH Chart

RSH data by YCharts

Here is a stock that looked cheap as can be -- a single digit P/E is cigar-butt territory. It looked cheap right up until its earnings (and then price) cratered and then once that happened it looked expensive on a P/E basis. P/E is a historical metric, and driving while looking through the rear view mirror can be hazardous to your wealth. Now, RadioShack has become a distressed stock, as it has reported negative earnings since 2012. 

For an example of a more straightforward relationship between price and earnings, consider the five-year history of Wal-Mart (NYSE:WMT)

WMT Chart

WMT data by YCharts

What could have tipped off RadioShack investors that the cheap price was a facade around a failing business? 

Let's look at four metrics that all trended poorly for RadioShack. Free cash flow peaked in 2007 and steadily headed south, and it went negative in 2012. Operating margin was not high to begin with, and it peaked at 9% in 2007 and declined to negative by 2012. Earnings per share also went negative in 2012. 

RSH Free Cash Flow (TTM) Chart

RSH Free Cash Flow (TTM) data by YCharts

Was there anything to tip off investors that 2012 would turn out to be an annus horribilis for RadioShack? One line in the chart stands out. The company was unable to raise its dividend for many years before the wheels came off the wagon in 2012. A lack of a dividend raise by itself is not as big of a red flag as a dividend cut, but a lack of growth does not demonstrate that the company is a thriving business either.

By contrast, Wal-Mart has been able to deliver solid dividend growth year in and year out. The ability of a company to continually raise its dividend is an important defensive characteristic.  

WMT Chart

WMT data by YCharts

Dividend growth does not guarantee that your stock will be a high flier and generate outsized capital gains in the short run. Dividend growth does offer some downside protection by providing the ability for a company like Wal-Mart to reward its shareholders directly. A lack of dividend growth can point to worse issues cascading across a business' operations. Even if you are not investing primarily for dividends it makes sense to pay close attention to this metric to shore up your portfolio's defense. 

Top dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That’s beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor’s portfolio. To see our free report on these stocks, just click here now.

Gunnar Peterson owns shares of Facebook and Google (C shares). The Motley Fool recommends Facebook and Google (C shares). The Motley Fool owns shares of Facebook and Google (C shares). 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.

A Financial Plan on an Index Card

Keeping it simple.

Aug 7, 2015 at 11:26AM

Two years ago, University of Chicago professor Harold Pollack wrote his entire financial plan on an index card.

It blew up. People loved the idea. Financial advice is often intentionally complicated. Obscurity lets advisors charge higher fees. But the most important parts are painfully simple. Here's how Pollack put it:

The card came out of chat I had regarding what I view as the financial industry's basic dilemma: The best investment advice fits on an index card. A commenter asked for the actual index card. Although I was originally speaking in metaphor, I grabbed a pen and one of my daughter's note cards, scribbled this out in maybe three minutes, snapped a picture with my iPhone, and the rest was history.

More advisors and investors caught onto the idea and started writing their own financial plans on a single index card.

I love the exercise, because it makes you think about what's important and forces you to be succinct.

So, here's my index-card financial plan:


Everything else is details. 

Something big just happened

I don't know about you, but I always pay attention when one of the best growth investors in the world gives me a stock tip. Motley Fool co-founder David Gardner (whose growth-stock newsletter was rated #1 in the world by The Wall Street Journal)* and his brother, Motley Fool CEO Tom Gardner, just revealed two brand new stock recommendations moments ago. Together, they've tripled the stock market's return over 12+ years. And while timing isn't everything, the history of Tom and David's stock picks shows that it pays to get in early on their ideas.

Click here to be among the first people to hear about David and Tom's newest stock recommendations.

*"Look Who's on Top Now" appeared in The Wall Street Journal which references Hulbert's rankings of the best performing stock picking newsletters over a 5-year period from 2008-2013.

Compare Brokers