When was the last time you bought a roll of film? I am no Luddite, but I am typically the last among my friends to adopt the latest technology--and even I haven't bought any film in at least two years. That explains, in part, the epic decline in the shares of Eastman Kodak (EK, $0.46), which, in the 1990s, traded at over $80 and are now priced at about 46 cents. While we could roll the stock into the CSI lab for a full head-to-toe autopsy, instead we'll look at how the investment community--or at least part of it--viewed the stock throughout much of its fall. Some research analysts and other market observers continued to insist that the stock was a good value for investors because it was cheap--It has fallen from its highs, it has a low P/E, it pays a good dividend, people won't stop buying film, it's an iconic American brand, blah, blah, blah. As it turns out with the distinct clarity of hindsight, the stock was cheap, but it was cheap for a reason--and it was going to get a whole lot cheaper.
EK is a rather extreme example of a "bear trap" or "value trap," extreme because most companies that could be setting up as such traps aren't actually facing the near-obsolescence of their core product. Instead, most suspected cases of value traps come on more subtly, like that first cough or body ache that may signal that you're coming down with a full-blown case of the flu. Investors love to find stocks that are truly cheap, values because the stock price does not fully reflect the growth opportunities that may lie ahead for the company. Successful investing requires that we distinguish between stocks that are undervalued for that reason and those that just appear to be undervalued but actually deserve to be cheaper. Would you really want to invest in a company that makes typewriters, regardless of how cheap the stock is? We'll look at some suspected cases of value traps and pose two questions to conduct our diagnosis: Is the company's product or service gaining or losing relevance for its customer market? And what is the catalyst that is going to make the stock go higher?
Our first patient is Radio Shack (RSH, $9.85). I have read numerous research reports claiming that the stock is a buy--at $15, then at $13, then at $11, and so on. As a teenager I would buy blank cassette tapes there so I could record my albums to listen to in the car. On my last trip to Radio Shack, some time last year, I bought some fuses for my stereo system--total sale less than $10. The company is trying to keep its stores relevant by emphasizing more wireless products, services, and accessories, but the only company that really seems to be thriving selling consumer electronics at a bricks-and-mortar location is Apple. Radio Shack may be around for a while, but its relevance does not seem to be growing.
Campbell's Tomato Soup and a grilled cheese sandwich may be the best comfort food ever invented. That's what I enjoyed as a kid, and it's what we'd serve our kids when they were home from school on snow days. (M'm M'm Good!) When my wife went shopping to load up on the condensed soups that go into the Thanksgiving and Christmas casseroles, I noticed that my value maven brought home the store brand, not the Campbell's. When I asked her about this, she explained that it really didn't matter since the soup was going into the green bean casserole. M'm M'm Bad for Campbell's--that's the last thing a company wants consumers thinking about its branded products. We are not health nuts at our house, but we still don't have that much use for a can opener. While I sill eat the Campbell's (CPB, $32) Tomato Soup on occasion, I really can't imagine chowing down on something like seafood gumbo out of a can. There are plenty of options for freshly prepared soups--or at least something closer to fresh. CPB also owns Swanson, Pepperidge Farm, Pace Salsa, Prego Pasta Sauces, and V8 Juice Drinks--an impressive portfolio of brands, in other words. That is why the diagnosis here is not terminal. Food is not film. However, the trend toward healthier eating habits is a headwind for the company, so while its relevance may be stable, it's not likely to grow. More than a hundred years ago, CPB figured out the way to remove half of the water from its soups. This meant that shipping costs were greatly reduced (water weighs a lot), so the company was able to charge a lower price point for their soups and capture a huge share of the market. That's called innovation, and if the company wants to see its stock price move up, it had better get busy innovating.
A Wall Street Journal headline from December 15, 2011, proclaimed, "Hasbro Falls Prey to 'Angry Birds'" (by Ann Zimmerman). The article details how Hasbro (HAS, $32), known for board games such as Monopoly, Battleship, Scrabble, and Operation, has suffered because they haven't done much to update those classics or introduce new games. Sales of Hasbro's boards games are down 9% over the last three quarters compared with last year, with the stock price down 30%. The company is also not clicking with its foray into online games--there are one million monthly Facebook Scrabble users compared with the 13 million users of Zynga's "Words with Friends." Hasbro is now focusing on movie tie-ins with its stable of toy characters. Kids will always play with toys, but the preference seems to be gaining for World of Warcraft over G.I. Joe. I can only wonder what Henry and Helal, the Hassenfeld brothers (Has-Bro), would think about their company today, some 60 years after they gave birth to Mr. Potato Head. Sorry, Bro.
Another early warning for value traps surfaces when a company's product starts to take on the characteristics of a commodity. The key aspect of a commodity, at least for our purposes here, it that the seller cannot differentiate the product to gain pricing power. If I am a corn farmer, I have to accept the price of corn that is determined by supply and demand in the commodities markets--that is what is known in economics as being a "price-taker." I can't differentiate my corn by branding it as "Jim's Corn" and charging a higher price. If I have an orange grove in California and a freeze destroys much of the orange crop in Florida, then the price of oranges will go up, and I'll benefit by realizing a higher price. That will be due to the changes in supply and demand, though, and not to any special feature that differentiates my oranges.
Televisions have become "commoditized" in this way, and that's part of the reason why shares of Sony (SNE, $17) have been in the dumps. When most people shop for that new flat screen television, they are looking for the combination of features and price that best suits them, and they are not as concerned as they once might have been with any particular brand. This was happening with cell phones before Apple redefined the landscape with the iPhone. Part of the genius of Apple, as we have noted before, is that they were able to avoid the commodity trap by branding their products and creating a technology ecosystem based on their operating system. It's part of the reason people are so excited about the possibility of an Apple television, because that could have the same effect. Just about every type of consumer electronics product out there has fallen victim, at least to some extent, to commoditization. IBM, the second-best performing stock in the Dow Jones Industrial Average for 2011, has been successful lately because they have shifted away from making computer hardware and focused on technology and software services.The last year saw shares of IBM up 22%, while shares of Dell were up 7% and shares of Hewlett Packard were down 40%. Unless you are part of the Apple ecosystem, do you really care who made your computer screen or printer? When everything is perceived as being more or less the same, the only competitive arrow left in the quiver is price.
I am not suggesting that any of these companies will go the way of Eastman Kodak. The point we need to take away as investors, however, is that it is not enough for a company merely to be stable. That's survival mode, at best. The stocks of Whole Foods Market and TJ Maxx are doing well, in part, because what they offer is growing in relevance, at least for now. The same could be said of companies that enhance the efficiency and effectiveness of healthcare delivery. As for any possible catalyst, there is always the potential for a company to unlock value for its shareholders by breaking itself up, selling off brands, or being bought outright. Radio Shack would be the loser here, because the only assets they really have are their store locations. Campbell's and Hasbro have valuable brands, and they both pay a nice dividend in excess of 3.5%. Some investors will say that these stocks are cheap, but we can find other cheap stocks that just might move in the profitable direction. And even if I am wrong about my specific value trap candidates, the overall warning about those traps remains valid. Finally, as much anguish that we feel when we're seeing our stocks drop in a declining market, it's also pretty frustrating to watch the market soar and have our stocks not participate in the rally. Over the last three months, the S&P 500 is up 7%, with HAS and CPB each down about 5% and RSH down almost 20%. Nobody likes to miss the party.
As for Eastman Kodak, the company now faces possible bankruptcy and a delisting of their stock. Maybe things would have turned out differently if they had realized sooner that they were not really in the film business, but in the business of archiving memories. The irony here is that Kodak actually invented the first digital camera. Thanks for the memories, EK.
Next time we'll look at the opposite situation, stocks that are firing on all cylinders because of their growing relevance. Until then.....
Life is short. Get busy.
Jim
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