This article is part of our Rising Star Portfolios series.
Radio Shack (NYSE: RSH ) and Best Buy (NYSE: BBY ) aren't popular these days.
Over the past year, the S&P 500 is up 18%. Radio Shack? Down 24%. Best Buy? Down 13%.
They are specialty retailers in an increasingly competitive space: electronics.
We know Amazon.com (Nasdaq: AMZN ) and its Internet retailer brethren are coming strong. So are the bricks-and-mortar competition like Wal-Mart (NYSE: WMT ) . And so is the wireless industry -- with companies like Verizon and Apple competing with their own stand-alone stores.
The first two nip at Radio Shack and Best Buy on price, the latter two on specificity.
And, honestly, I'm not really that stoked about the prospects of Radio Shack or Best Buy in the long term (think 10 to 20 years from now).
So why am I interested?
Radio Shack trades at a trailing and forward P/E ratio of 8 while Best Buy's at 10 and 9, respectively. And those numbers are about the same when we look at them on a trailing cash flow basis (using enterprise value to free cash flow).
Now, price is nice, but we have to have at least some faith in their ongoing operations.
The case for Best Buy
The case isn't hard to make with Best Buy. While it's seen some margin compression in recent years, it's been able to grow its top line pretty consistently. When a company's trading at price multiples of 10 or lower, not much growth, if any, is factored in. While it faces increasingly stiff competition, I think its value proposition of being a physically located, specialized, one-stop-shop for electronics has some legs for the medium term (the next few years, at least).
The case for Radio Shack
The case is harder to make for Radio Shack. When I say "Radio Shack," you're probably thinking two things: (1) How the heck is that place still in business, and (2) isn't it just a clubhouse for nerds to get replacement parts for their ham radios and Ataris?
Before you pre-judge, check out this stat. I'm setting phasers to stun:
Radio Shack has made a profit in each of the last 17 quarters!
That means Radio Shack was pumping out profits throughout our housing meltdown and recessionary problems -- all the way back to the fourth quarter of 2006.
That's the same year Radio Shack hired Julian Day as its CEO. He had previously won kudos for his work in resuscitating Kmart. Under Day, Radio Shack has seen serious cost cutting, a rebranding campaign focused around "The Shack," and an increasing emphasis on being a multi-carrier wireless store (more than a third of its sales are from wireless). And while its kiosks at Sam's Club are being discontinued, Radio Shack is ramping up a larger wireless-featuring kiosk deal with Target (NYSE: TGT ) .
Still, its emphasis on wireless in its stores, while a lifesaver, is dangerous since Radio Shack will face more competition from the very providers and hardware makers whose products it sells. And with its butt-kicking CEO stepping down in May, Radio Shack's ability to respond is in question.
But at its current stock price, I'll take that chance.
I try to take my opportunities where the market is presenting them. Right now, the market is discounting the prospects of Radio Shack and Best Buy. They may not be the best businesses out there, but they're pretty cheap, they have solid balance sheets, and they've shown a good track record of profitability. As evidence of the profitability, note that their five-year price multiples on earnings and cash flows are close to their one-year multiples.
I'm not expecting a home run from either (though I'd gladly take it) but rather a solid, market-beating performance.
My thesis hinges on two things: (1) the businesses of Radio Shack and Best Buy staying steady (or growing!) over the short to medium terms, and (2) the market upgrading its hatred to lukewarm thoughts sometime in the next three to five years.
I believe strongly enough in this thesis that tomorrow I'll be buying shares for my Motley Fool-funded real-money portfolio. You can see all of my real-money picks by clicking here.