It was a day in August, 2006 when some kid whizzed past me on these shoes with wheels, almost knocking me over. I was instantly annoyed -- not at the kid, despite my occasionally curmudgeonly attitude -- but because I instantly recognized these so-called Heelys (Nasdaq: HLYS) as a fad that was going to cost a lot of people a lot of money.
Turns out I was right.Yeah, the stock briefly hit $40 two months after its IPO price of $21. But that was its peak, and the stock rightfully rests at $2.12 today. Why?
Because it is a fad. A one-trick pony. A one-hit wonder. And its registration statements said as much -- the vast majority of its sales came from one style or another of the same darn product. If they sell perennially, you have a sustainable business. If not, watch out.
Some say these items aren't easy to spot, that today's fad could just as easily become tomorrow's Microsoft! I say, "feh." All it takes is a little imagination. If you look, as I did, at Crocs (Nasdaq: CROX) and can't come up with any other possible use or expansion of the product in 60 seconds, then it's a fad.
Think of Amgen (Nasdaq: AMGN). The company never has just one possible drug in its pipeline. It has dozens. Think of Apple (Nasdaq: AAPL). It is constantly innovating. Think of Procter & Gamble (NYSE: PG), Johnson & Johnson (NYSE: JNJ), and 3M (NYSE: MMM). They all make products people need, and that they will buy in good economic times and bad, and these companies all constantly innovate to make sure things stay that way.
Plus, another reason to avoid Heelys is the potential for nasty lawsuits. If a woman can sue McDonald's for putting hot coffee in her lap, some parent is going to blame Heelys when her kid slams into a bus.
If you thought Heelys was some great new concept that would sweep the country like Starbucks, then maybe you didn't know that Fool co-founder and advisor David Gardner asks several questions before recommending a company for his Rule Breakers portfolio -- and Heelys never had a chance to make the cut as a Rule Breaker. Here are a few of those questions (and my answers):
1. Is it the "top dog" and "first mover" in an important, emerging industry?
Footwear is not an important, emerging industry.
2. Does it have a sustainable advantage?
No, it's just another type of footwear with no intrinsic, long-lasting consumer advantage.
3. Is good management in place with smart backing?
Management executed within the product's inherent limitations, but had no plans to take it beyond its initial concept.
4. Does it have strong consumer appeal?
No. It's just a niche, although reasonably sized, market.
Those are a few of David's criteria. You should hold your own portfolio to the same standards.
A few other warning signs to look out for if you're concerned you own a fad company:
- Supporters who rabidly and irrationally insist it isn't a fad.
- When sales inevitably decline, supporters who find something in the earnings report to trumpet (increasing year-over-year sales on rainy Tuesdays, for example).
- Claims that the company will resurrect by "re-branding."
So here's where the rubber meets the road: On July 14, Heelys new CEO stated, "I believe there are several cost and infrastructure opportunities that can be optimized ... We will address those issues and begin to restage the Heelys brand day one."
The skid marks are on the street, folks. They lead to the poor house.
Other highly relevant Foolish fad reading:
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