When a high profile company collapses, people tend to take notice. Especially when it is a well-known retailer like Circuit City was. There were many contributing factors to the Circuit City bankruptcy, but it’s easy to say it was obvious with hindsight. Or was it?
Circuit City enjoyed a chief prosperity during the 80’s and 90’s. Business was booming and naturally, it was expanding. People were buying up everything in the stores, from electronics to appliances… it was starting to be known as the store to buy from before you head off to college.
But the good times didn’t last forever, and eventually it slowed down. The retail empire took a backseat to Best Buy. They stopped selling their profitable appliances. Growth diminished, before it became hard to get customers in the store at all.
The Circuit City Bankruptcy
By the time that the housing crisis meltdown hit and the economy entered into a full blown recession, Circuit City was on life support and couldn’t take it any more. On November 10, 2008, Circuit City filed for bankruptcy.
How could this have happened to such a great store? Of course there’s plenty of speculation, but former CEO Alan Wurtzel thinks that it’s because management didn’t adapt.
He blames executive pride, as well as the inability for radical change due to shareholder backlash, as contributing to the eventual demise. In an store selling technology, is it really a surprise that you need to be on your feet and can’t rely on the past?
These are questions that aren’t as obvious as they seem to be. Surely for Circuit City, these are questions that weren’t pondered enough and you see the consequences of that. But is it really that easy? Sure you can look back as you sit in your chair and say that this one factor was the final straw, but I don’t think it was ever that simple.
Most people don’t realize that one of the riskiest sectors in the stock market is retail. I’ve written about this before, how the retail industry had the most major bankruptcies out of anyone since 1994.
Although retail is very well known and certain brands easily become household names, it is very hard to stay in business in that industry. There’s so many factors that I can’t give you just one reason, but it’s hard to argue with the facts.
So knowing this fact and then reexamining this story, it shouldn’t be that shocking that a company as well known as Circuit City went under. If you look at the numbers, it’s even less.
Take a look at the last annual report before the Circuit City bankruptcy, filed on April 28, 2008 and compiled into a spreadsheet for your convenience by yours truly.
Before we move on I want to include the Value Trap Indicator values as well, as they’ll really help us get a good picture of what’s going on. Also understand that parenthesis () means a loss.
Right away, look at how fast the Value Trap Indicator went from a Strong Buy (< 250) to a Strong Sell (> 800). Looking at the stock price for the outcomes gives quite a favorable result.
With the Value Trap Indicator, you would’ve bought in 2005 around $10-$17, bought again in 2006 around $15-$25, and then sold in 2007 at around $19-$31.
A quick double, and you would’ve avoided the bankruptcy! The Circuit City bankruptcy is a perfect example of how fast things can change, and what a value trap can really look like. In 2007 and 2008, Circuit City had all the makings of a value trap.
They continued to pay and increase their dividend. Their valuations sunk lower and lower as the price continued to fall. For all intents and purposes, it really seemed like you were getting a great deal on some unfavored assets!
Sell on Negative Earnings!
Again this goes back to what I’ve taught before. You need to look at every category, and don’t ignore the glaring problem that a stock is showing you. In this case, the negative earnings are extremely problematic.
When you buy a company with negative earnings, you might as well go to the casino and put it all on black. Because when you buy a stock that is losing money you aren’t buying a business, you’re buying a liability with a chance of recovery. Sure it might just recover, but the risk isn’t worth it when there are literally thousands of companies out there with positive earnings. Just don’t do it!
Would you buy a broken down car at retail price? Or even if you bought it at a discount, is it worth it? Let’s pretend you actually did have mechanic skills. But imagine buying a car that you aren’t allowed to touch, and it’s going to be repaired by someone randomly off the street. No sane person would ever do that!
Yet millions of people do it in the stock market all the time. And the markets, customer wants and demands, and the health of industries and the economy is as random as can be! At least put yourself in a favorable position by buying a company that’s actually making money!
If you go back and read my 7 Steps to Understanding the Stock Market, you’ll remember that one of my iron rules is to sell a company with negative annual earnings. No matter what!
Look at the Circuit City example. All it took was 2 years of negative earnings before the business was done. And this was with a company with very nice financials in 2006 and 2005. Even the debt levels were low enough to ward off trouble. It was the lack of earnings that did them in.
Hopefully it’s all coming together now. Maybe you’re starting to see that there is a method to the madness known as the Value Trap Indicator.
You’d be right.
This blog post is part of the Stock Market History series. This series tries to uncover what went wrong in the biggest stock market bankruptcies, and how investors can use these lessons to prevent major losses in their own portfolio. This Stock Market History series shows the Value Trap Indicator values in the years right before a company went bankrupt. As you’ll soon see, many of these bankruptcies could’ve been easily avoided by following the Value Trap Indicator.
Today, there’s one portfolio that utilizes the Value Trap Indicator to find the best deals in today’s market for continuous compounding and superior returns. Those stock buy ideas are published monthly in the Sather Research eLetter, complete with research and Value Trap Indicator values. To subscribe to the Sather Research eLetter, click the link.
**All Rights Reserved. Investing for Beginners 2014**
**2008 Stock Market History: Circuit City Bankruptcy**