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A Scary Stock? Oh Yes!

By Alyce Lomax - Updated Apr 5, 2017 at 8:06PM

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Sears Holdings has become a poster child for value traps.

Sears Holdings (NASDAQ:SHLD) has never been on my list of promising retail stocks to consider buying. The competitive challenges (hello Wal-Mart (NYSE:WMT), Target (NYSE:TGT), Costco (NASDAQ:COST), etc.) that Sears faced in the retail world were just the tip of my bearish iceberg. However, yesterday I realized things have gone from bad to worse, and I think investors should stay far, far away from Sears.

When businesses and balance sheets erode
My negative outlook on this stock (the parent of both Sears and Kmart stores) goes far beyond the fact that Sears swung to a third-quarter net loss of $146 million, or $1.16 per share, compared to its profit of $4 million, or $0.03 per share, this time last year. It also goes beyond its 8.3% drop in sales, or 9% drop in same-store sales, in the third quarter. Admittedly, these aren't exactly good. But then there's the cash-burn factor.

I was looking at Sears' historical data and realized that it has been running through its cash during the years. In the year ended January 2006, Sears had $4.4 billion. It now has just $1.2 billion. It also has $2.2 billion in debt. Granted, it has been paying debt down, but these days, I feel investors should weigh debt very carefully and very negatively, particularly in retailers with eroding operational strength.

Worst of all, as the company's cash has dwindled it has been busily buying back stock. That might be fine and dandy except for the fact that the stock has subsequently plunged. Sears' 52-week high was $116.79, you may recall. Now, Sears' press release said it plans to buy back another $500 million. It seems like buybacks and financial engineering are all Sears has had in its arsenal; it certainly lacks operational strength as an actual retailer.

This ain't no Berkshire Hathaway
Back in October, when we were contemplating the World's Scariest Stocks here at the Fool, I was a bit preoccupied with my own nomination, Talbots (NYSE:TLB). However, my Foolish colleague Rich Duprey offered up Sears, making many of these very points about its dwindling strength -- yep, it's a frightening stock, all right.

Eddie Lampert has only managed to turn Sears into Berkshire Hathaway's (NYSE:BRK-A) (NYSE:BRK-B) dorky, underperforming twin, not the next Berkshire Hathaway. Meanwhile, the real estate thesis that many have held so dear to their hearts has also gotten hit with the wrecking ball of reality. Commercial real estate in general is looking super dicey given the economic situation at hand, and many retailers are struggling to survive. So who'd even buy, if it came to that, and at what price? 

Behold a textbook value trap
Sears' price-to-earnings ratio has dropped precipitously (along with the stock, of course) ever since Rich nominated it as a chiller, but I wouldn't be tempted to think this stock is really cheap. With all due respect to my colleagues at Motley Fool Inside Value, who recommended Sears awhile back, I have to say that Sears continues to strike me as a poster child for value traps: a company that has too often been more about financial engineering than doing a darn thing about reinvigorating its actual business. (And come on ... haven't we all had enough "financial engineering" these days? Sears has been known to play around with derivatives called "total return swaps" -- uh, thanks but no thanks.)

Investors should instead spend their time researching real retailers, with real futures, with little or no debt and positions of competitive strength. They're out there, and some of them are dirt cheap, too. When it comes to Sears, buyer, beware.

Looking for what's hot -- and totally not -- in retail? Check out this related Foolishness:

Sears Holdings, Wal-Mart Stores, and Berkshire Hathaway are Motley Fool Inside Value recommendations. Costco Wholesale and Berkshire Hathaway are Motley Fool Stock Advisor picks. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletters today, free for 30 days.

Alyce Lomax does not own shares of any of the companies mentioned. The Fool has a disclosure policy.

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Stocks Mentioned

Sears Holdings Corporation Stock Quote
Sears Holdings Corporation
SHLDQ
Wal-Mart Stores, Inc. Stock Quote
Wal-Mart Stores, Inc.
WMT
$127.61 (0.81%) $1.03
Target Corporation Stock Quote
Target Corporation
TGT
$166.97 (0.51%) $0.84
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
BRK.A
$439,167.01 (-0.08%) $-361.91
Costco Wholesale Corporation Stock Quote
Costco Wholesale Corporation
COST
$541.90 (0.23%) $1.23
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
BRK.B
$292.34 (0.09%) $0.27

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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