It's been a difficult ride for Foot Locker (FL 0.23%) shareholders. In the past five years, the stock has tanked 47%, a huge disappointment compared to the 58% gain of the S&P 500. 

The negative trends were propelled more recently by the latest quarter's financials, which missed Wall Street expectations, and guidance that was significantly downgraded. So it can't come as much of a surprise that the stock is down 34% in just the last three months (as of Aug. 12).  

But should investors completely avoid this retail business? I think that's a wise decision. Here are three major red flags that explain why. 

Poor financial performance 

In the most recent quarter (first-quarter 2023 ended April 29), Foot Locker saw its revenue decline 11.4% year over year. Same-store sales were down 9.1%, and the net income fell 73% to $36 million. 

For the full fiscal year, management expects sales to fall between 6.5% and 8%, a substantial downgrade from just three months prior. The gross margin is also forecast to contract due to higher promotional activity. The leadership team puts the blame on the softer macroeconomic environment that is pressuring consumer spending on discretionary items. 

While this explanation makes sense on the surface, looking at a key rival in the industry provides more evidence that Foot Locker's struggles might be unique to its own operations. In the 13 weeks that ended April 29, net sales for Dick's Sporting Goods increased 5.3% year over year, with net income jumping 17%. Clearly, Foot Locker is losing share in the retail market for athletic footwear and apparel. 

Lack of competitive advantages 

Foot Locker's management team is working on a "Lace Up" strategic plan to refocus the business and get it back on track to achieve profitable growth over the long term. But this will prove to be difficult, given that the company lacks any competitive advantages, in my opinion. Foot Locker doesn't benefit from network effects or switching costs, and economies of scale seem nonexistent. The company's operating margin has actually declined over the past decade. 

An argument might be made that Foot Locker has a competitive strength in the form of its brand recognition. This could at least keep the business relevant. But I don't think this matters as much as it used to, as people aren't as keen on visiting shopping malls as they were a couple decades ago. 

Moreover, there's a seemingly unlimited number of retailers that compete in the market for athletic apparel and sneakers. This makes it more challenging for Foot Locker to find ways of standing out among the crowd. 

Brands going direct-to-consumer 

Gone are the days when companies needed to depend heavily on retailers and their shelf space to gain access to customers. The internet changed that, as brands are increasingly skipping third-party brick-and-mortar channels and going direct to consumer via their own stores and digital properties. Just look at Lululemon, for example, which doesn't use any wholesale accounts to sell its incredibly popular merchandise. 

Nike, which represents about 65% of Foot Locker's sales, is also trying to generate more of its revenue from digital channels. That move can help boost margins by essentially eliminating the middleman. It's worth pointing out that while Nike and Foot Locker have a positive working relationship, it's evident that the latter relies far more on the former's cooperation.

Between 2022 and 2027, Foot Locker plans to close 300 stores, bringing the count to 2,400. Changing the physical footprint to match tempered demand expectations is a smart strategy, especially as it relates to improving the financial situation. 

But it's also an admission that people shop differently than they did even just a decade ago. The ongoing penetration of e-commerce, which only represents 15% of all retail spending in the U.S., is a secular trend that will likely play against Foot Locker going forward.