How We Avoided Sharper Image

The Kelly Letter began watching Sharper Image a little over a year ago when it traded at $10. It looked like a potential turnaround candidate, on the same path as RadioShack, then on its way to a six-month 100% gain from December to last June.

I wrote to subscribers on January 6, 2007:

Sharper Image reported same-store sales on Thursday, and they weren’t good on the face of it. They dropped 20% in December. That was after a widespread promotional campaign. However, it was less of a decline than the store saw in the previous three months: -27%, -31%, and -21%. That’s small comfort, but is a move in the right direction. This is, after all, a turnaround candidate. It’s a risky one, though, and I’m holding out for $9 as an entry at what looks like support on the chart.

The stock never bottomed out as low as I was hoping for, and instead began a steady climb to more than $11.50 by April, a three-month gain of 20%. Chart readers pointed out that the stock’s MACD reading issued a steady buy signal at the end of March, and that we’d missed our entry.

I wrote at the end of March:

Sharper Image rose 6% this week, thanks to a new president being on the way. Its numbers are still lousy, though, and I imagine there’s another bad quarter or two ahead of it before new management gets the arrows pointed up. . . . I moved our Sharper Image target price up to $9.50 from $9, but will strongly consider buying anywhere under $10.

The stock dropped below $10 in mid-May, but still we didn’t buy. Onlookers were upset when I wrote on May 19:

Sharper Image ended the week at $9.87, and I lowered the target buy price to $9 from $10 as we’ve seen strong downward momentum in the past few weeks. Patience looks set to pay again.

“Jason,” wrote one exasperated subscriber, “you raise the target price when the stock goes up and lower it when the stock comes down. We never buy. When are we going to get onboard this train?”

You can imagine how upset people were when the stock bottomed out just three days later at $9.33, flashed an MACD buy signal the next day, and then ran up 52% to $14.16 by June 6. All the while, I maintained a $9 buy price target and kept repeating that I was not watching the stock as a trade but as a long-term recovery story. Unfortunately, that carries little weight to those who were champing at the bit to buy.

Then, however, a funny thing happened. The stock began to fall. On July 27, it finally broke through our $9 price target, but still we didn’t buy. I wrote on July 28:

Sharper Image fell 11% this week to $8.84, below our former target price of $9. Its chart shows a 34% dive lower from its $13.37 close on June 13. That’s steep and should not be touched until it levels out.

There’s not much sign of life at Sharper Image yet, and the currently weak market environment should contribute to shares getting even cheaper for us to buy for the eventual turnaround.

I’ve moved the target price down to $8.

Three weeks later, on August 17, the stock closed 59% lower at $3.65. The following week, it rose 29%, thereby attracting the same crowd of angry emails that bounces earlier in the year had attracted. I wrote that weekend:

Sharper Image dropped 48% last week and gained 29% this week. The bounciness smacks of pure price speculation and is of little interest to us. What we’re looking to buy as cheaply as possible is fundamental improvement at the company. We haven’t seen signs of it yet, so we’ll keep waiting.

“By the time you get it,” wrote one reader, “the price will have anticipated the improvement and the massive early gains will be gone.” I replied that, be that as it may, I was not willing to tell subscribers to buy stock in a company with such lousy numbers and low prospects. “I don’t mind buying a distressed situation,” I wrote, “but I refuse to buy an impossible situation that depends on market gyrations alone to create a profit. That’s gambling.”

The stock continued a gentle but steady downward trajectory until mid-October. I wrote on October 13:

I’m sure you’re glad that we’ve only been watching Sharper Image and not buying. The stock fell 44% this week.

The reason is that a federal judge rejected the company’s proposed settlement to distribute $19 coupons to people who bought its air purifiers alleged to be defective in a class-action lawsuit.

In support of its proposal, Sharper Image made the impression that the settlement is the best customers should hope for because the company is on the verge of bankruptcy.

That’s not good for investors to hear.

On the same day, the company reported that its sales fell 39% in September compared with a year ago. Same store sales fell 21%. Catalog sales fell 62%. Online sales fell 51%.

The company may be a goner, but it may also be an unbelievable value, the way Chrysler was when Warren Buffett bought it at $2 when it, too, was on the verge of bankruptcy. One big difference is that Chrysler had tangible assets. Sharper Image doesn’t. It needs a whole new product line, evidently, and a management team with the skills necessary to build it and reshape the business.

I’m skeptical at this point, but interested enough to keep watching. I lowered to price target from $3 to $2.

The plunge continued until SHRP had fallen 52% in one week to close October 16 at $1.81. Still, we held off buying even though it had fallen through yet another lowball price target. A week later, it was up 83% to $3.32, and it appeared that the letter had blown it again.

The stock moved sideways for six weeks, but news from headquarters offered little reason to hope during the holiday shopping season. I wrote on December 2:

Sharper Image is still floundering, and my interest in the company will get a big update after we see how it fares this holiday season. It may just be finished. It may be the biggest turnaround potential we’ve been following in the past two years. It’s too early to say much, so I won’t.

The familiar gentle but steady slide lower took over again, and the stock was down to $2 by the beginning of this month.

Then, yesterday, Sharper Image filed for bankruptcy and said it will close nearly half its stores. BusinessWeek wrote that “some analysts believe Sharper Image had unique troubles that contributed to its bankruptcy: deep reliance on a single product for most of its history and high costs due to expensive retail locations and catalog printing.” That one product, an air purifier, accounted for 35% of sales. SHRP shares fell 71.5% to 41 cents yesterday on the news.

Were we silly to even have been watching so carefully for the last year? I don’t think so. Many deep value turnarounds look precisely as troubled as Sharper Image looked. Had it diversified its product line-up, more aggressively closed various locations, and come up with a smart holiday campaign, there’s a chance it might have regained its stride.

What then kept us out of the stock at so many points that looked good along the way to destruction? After all, it showed buy signals on the charts. Those weren’t illusions. They were, however, short-term signals irrelevant to us for a long-term return to corporate health.

Some have pointed out that traders with quick instincts might have been able to benefit from the short-term buy signals. Maybe. I doubt it, though. Despite what you read, very, very few people are able to call short-term ups and downs. So few, in fact, that the ones who do are considered to be merely lucky by serious students of the subject. Why? Because they can’t repeat the feat. Last week’s hotshot is this week’s dunce. So, I don’t feel bad for missing those trades.

What I feel good ab
out was having the discipline to wait for promising signs of fundamental improvement. We never got them, not even as much as one compelling idea for a turnaround. I visited Sharper Image stores and they paled next to Brookstone and others. Real world research counts, and Sharper Image just wasn’t sharp anymore.

Luckily, some of the other stocks we watched for nearly as long finally hit our lowball price targets in January’s sell-off. There’s always a reason to be thankful.

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