Shame on Forbes!

On Monday, the respectable financial publication sullied its reputation by syndicating shoddy advice from the Dividend Channel, trumpeting struggling electronics retailer, RadioShack (NYSE: RSH), under the headline, “This Stock Has A 12.14% Yield And Sells For Less Than Book.”

What’s so wrong about recommending a cheap stock with an above-average yield? In this case, everything! And here’s why…

[ad#Google Adsense 336×280-IA]Why Chasing Yield is Always a Bad Idea

Yield is always a function of price.

The lower a stock falls, the higher its yield goes.

But price is always a function of the underlying business.

So if a company’s fundamentally strong, and keeps increasing earnings, its share price will naturally head higher.

Conversely, if a company’s fundamentally weak, marked by continually declining earnings, its share price will naturally head lower.

What’s my point? Well, if we’re evaluating a potential dividend stock, a double-digit yield should always be an immediate deterrent, not a come-on.

It’s a huge red flag that something’s wrong with the underlying business. And RadioShack proves my point wonderfully.

In the last year, the stock’s down 66.1%, pushing its yield from about 2% to 12%. But we can’t blame this on the market. Over the same period, the S&P 500 Index is up 8.4%. So, clearly, the collapsing stock price and soaring yield is symptomatic of a struggling business.

Of course, you don’t need me to tell you that RadioShack’s struggling. Just ask yourself, “When’s the last time I was in a RadioShack store?” Can’t remember, can you?

Neither can a large majority of consumers.

Whereas the average retail company enjoyed an average annual sales growth of 7.5% for the last three years, RadioShack posted an anemic 1.5% sales growth rate.

In terms of profitability, the picture’s even uglier.

The average retail company increased earnings by an average of 21.8% per year over the last three years. Yet RadioShack’s earnings are down an average of 23.8% per year over the same period, according to Morningstar.com data.

That statistic is particularly damning to Forbes because the Dividend Channel article boldly – and wrongly – touts RadioShack’s “favorable long-term multi-year growth rates in key fundamental data points.”

I don’t know about you, but 1.5% and -23.8% don’t exactly qualify as “favorable” in my book.

Of course, the earnings statistic is even more damning for RadioShack. In an industry where brick-and-mortar electronics retailers are a dying breed (think Circuit City), it appears to be next up for extinction.

I make that prediction based on the following facts:

  • In January, management canceled the $200 million stock repurchase program it instituted in late October 2011. Such a sudden reversal is not a sign of financial strength.
  • In the last quarter, comparable store sales dropped 4.2% year-over-year and the company swung to a loss of $8 million.

At the very least, RadioShack’s dividend is in jeopardy of being cut or eliminated altogether. This fact was revealed on a conference call in February, where CEO, James Gooch, conceded executives are reviewing the company’s dividend policy.

Bottom line: RadioShack sports a high yield and cheap valuation for a good reason. But look out, because before long, the only thing it might be sporting is a cheap valuation. Dividend investors beware!

Ahead of the tape,

Louis Basenese

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Source: Wall Street Daily