I'm a big follower of music, not only for enjoyment -- but also because I believe it's an industry that teaches a lot about the importance of mass appeal in investing.
There's a story I read recently about an aspiring star who sits down with a top music producer -- the producer immediately pulls out a series of flash cards -- and asks the would-be artist to look through them.
Doing so, the young man finds black-and-white silhouettes of well-known rap stars, which the producer immediately began to quiz him on: "Who's that? Who's this?"
The upstart names each one, easily. Identifying exactly who the artists are, even without faces -- by zeroing in on telltale features like a trademark hat, a signature necklace or a unique pose.
At which point the producer leans in and says, "Exactly. How are people going to recognize you?"
His point was this: To be appealing and memorable, a brand needs to hold certain qualities and be easy to define.
The same is true of great businesses.
The most successful businesses in the world -- and usually some of the best investments -- have brands that are easy to define and possess just a handful of key qualities.
Just think of how many successful companies can be summed up in a few words.
All of these firms have also carved dominant niches that make it clear to investors exactly what they can expect from these businesses, and why they should be excited about them as investments.
Firms that don't follow this mantra struggle.
I can't think of a better example than RadioShack (NYSE: RSH) -- a firm that's collapsing before the eyes of investors, despite being a once-hallowed name across the United States.
The retail firm reported fourth-quarter and year-end earnings earlier this month. And the results were ugly.
RadioShack's fourth-quarter loss widened to more than $190 million -- greater than triple the loss of $63 million the company reported for the same period of 2012.
The stock plummeted 17% on the news. But what's more telling is, as the chart below shows, RadioShack's investors have suffered a near-complete wipeout over the past four years, with the stock declining 90% since early 2010.
The future isn't looking any better. RadioShack announced it will close up to 1,100 stores across the United States -- over 20% of its stores. All of this has analysts predicting bankruptcy and the potential demise of the company.
RadioShack's lack of a defining "theme" shows how not to build a successful firm. In fact, it's the worst business I can think of.
The takeways are especially apparent when we run the company through the list of qualities I use to look for great businesses in my premium newsletter, Top 10 Stocks. (We only buy what we consider to be some of the world's best-run businesses.)
Consider the following points:
The world's greatest businesses sell their products at premium prices. RadioShack has actually been trying this strategy -- attempting to increase its margins to improve profits. The problem is that consumers need a justification for paying premium prices. An iPhone is more exciting than an LG Optimus. Coke (NYSE: KO) is more loved than Mr. PiBB. There's something more special about a diamond in a Tiffany (NYSE: TIF) box than a diamond from J.C. Penny (NYSE: JCP). RadioShack is... none of the above.
The world's greatest businesses sell products used in day-to-day life. RadioShack has been moving opposite to this rule -- looking to sell more complex and obscure private-brand products. The less simple your product becomes, the tougher your business execution gets.
The world's greatest businesses have a global reach and appeal for their product. Anyone who's been to Tokyo's giant Akihabara electronics district knows that RadioShack will never have global reach. Most countries have their own retail electronics businesses -- many of them extremely advanced. To be truly global, a business must offer a completely new experience, unavailable in the homeland -- the way a firm like Starbucks (Nasdaq: SBUX) does.
The world's greatest businesses have unlimited growth potential. It's hard to add new products or revenue streams to your business when customers are increasingly avoiding your existing lines. Once you lose consumer eyeballs, you've lost much of your ability to move in new directions.
The world's greatest businesses have clear competitive advantages that dominate their competition. This one is a complete bust for RadioShack. Name any aspect of retail and there's a competing firm that does it better. RadioShack isn't the cheapest, hippest, or most wide-reaching. It's struggling to catch up everywhere.
The world's greatest businesses generate enormous cash flow with low capital spending requirements. As mentioned, RadioShack has been trying to turn things around by adding new products to its stores. But every new product means a completely new purchase of inventory -- at significant expense. This is even more risky when you're dealing with unproven new products. RadioShack could end up with a lot of capital spending and little in the way of sales.
The world's greatest businesses have extremely high profit margins, or at least margins that outpace its broader industry. This is tough to do when you can't charge premium prices. RadioShack lacks the scale of a competitor like Best Buy that would allow it to drive down inventory and distribution costs in order to improve margins.
To call RadioShack the world's worst business is somewhat of a hyperbole. But there are an awful lot of cautionary points here -- fatal flaws that all investors should be looking for as they survey other businesses in the retail sector and beyond.
I believe this also reinforces one of the core beliefs of Top 10 Stocks -- that the world's best investments hold simple yet fundamental things in common. These drivers of success come down to philosophy rather than financials.
So far, we've seen excellent results over the past few years by following this strategy. In fact, out of the 16 holdings in our Top 10 Stocks portfolio, 14 have been profitable and more than half are up over 22% since we recommended them. Some have even gained 41%, 45% or even 59% in less than 3 years. (I talk about a few of these market-dominating companies in my latest research, which you can view here.)
Simply put, by looking for firms doing the "little things" right, you can find investments that will generate value for years to come -- and avoid those that destroy shareholder wealth.
P.S. -- The only thing better than investing in high-quality companies is investing in high-quality companies that return money directly to shareholders. In my latest research, I've found 13 market-dominating companies that have been hoarding billions in cash since the financial crisis -- and they're set to pay out $39.5 billion in dividends in 2014 alone. And that's just the beginning. To get access to the names and ticker symbols of some of these companies, simply view this special report.