Hazard Signs at Circuit City

Circuit City (NYSE: CC) has filed for bankruptcy protection, and I'm certain that many shareholders are shocked and outraged. Some may vow never to invest in stocks again, after being burned so badly. If only there had been some warning signs along the way to alert them to the danger!

Oh, wait. There were plenty of warning signs.

I've failed to notice red flags about some of my own holdings; after all, no investor is perfect. Still, Circuit City's hazards were hard to miss:

• In March 2007, the company announced that it was laying off 3,400 workers. (It also outsourced much of its information technology work to IBM (NYSE: IBM).) Such massive job cuts would be worrisome enough, but Circuit City went on to call the freshly pink-slipped workers overpaid, and announced plans to replace them with new, less expensive employees. Yikes. Given all the tough competition it faced from Best Buy (NYSE: BBY), Circuit City may simply have been scrambling for ways to cut costs. But that particular round of layoffs sent a lousy message to remaining employees, and any damage it did to morale couldn't have helped the company's performance.
  
• In July 2008, fellow struggling retailer Blockbuster (NYSE: BBI) dumped its plan to buy Circuit City.
  
• On Oct. 30, 2008, a little more than three months before the company filed for Chapter 11, my Foolish colleague Alex DuMortier wrote "Circuit City Will Burn Your Portfolio." Among other things, he noted the company's average annual return of negative 25% over the past five years.
  
• Also in October 2008, fellow Fool Alyce Lomax wrote about troubled retailers, noting that Circuit City had negative operating income. That meant it wasn't generating the dough it needed to pay down its debts. Not a good sign. (Alyce also cited Talbots (NYSE: TLB) and Borders (NYSE: BGP), both of which have since fallen in price.)
  
• Just a week or so before filing for bankruptcy protection, Circuit City said it would close some 155 stores, shrink its workforce by 17%, and work to renegotiate leases with landlords. That sure didn't sound auspicious.

In 20/20 hindsight, investors should have seen this coming. The possibility that Circuit City may have been a value could have sidetracked them; these days, so many companies look cheap. To avoid suffering through another Circuit City, make sure you're looking for red flags like these when you do your homework about the stocks you want. If you'd like some pointers toward promising, undervalued companies, try our Motley Fool Inside Value newsletter service free for 30 days.