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3 Reasons to Sell Urban Outfitters

Urban Outfitters is struggling with slow store traffic.  IMAGE SOURCE: URBAN OUTFITTERS INC. 

Urban Outfitters (NASDAQ: URBN) shares have underperformed for the last one, three, five, and 10 year period versus the S&P 500 Index. From a financial perspective, it's easy to see why; while Urban's revenue growth has nearly doubled since 2009, profits have barely budged.

There are three reasons why I believe investors should sell Urban Outfitters in favor of greener pastures.

Urban Outfitters and...pizza?

As technology is disrupting physical retail locations, some retailers are having to downsize by closing stores. Urban Outfitters' management has been able to grow revenue by continuing to open stores. However, the company's namesake brand has been struggling with weak store traffic, and in an attempt to alleviate this problem management decided to acquire the Vetri Family group of restaurants in November 2015.

I get the logic: you connect a pizzeria with a retail location to incentivize customers to "hang out" around an Urban store and therefore create higher engagement with the brand.

But operating a restaurant is an entirely different task than operating a retail store. More importantly, this is a classic example of what Peter Lynch defined in his book, One Up On Wall Street, as "diworsification" -- a business straying outside of what it knows best in order to find growth. These moves usually end up destroying shareholders' investment.

Inconsistent

Offering potential customers tasty food to spend more time in store only points to Urban Outfitter's weak position in the industry. A few years ago, it seemed the fast growing Free People brand could pick up the slack for slower Urban brand growth, but even traffic at Free People stores has begun to show some inconsistency in recent quarters.

Management has blamed slow growth on fashion misses as well as too much inventory from too many stores. This is a very careful way to state there is too much competition, and the blame on fashion misses points to the inherent risk in a retailer like Urban Outfitters.

The growth of e-commerce has left the traditional retail industry with too many stores, and new brands have emerged that are solely reliant on e-commerce, with no traditional -- and expensive -- brick-and-mortar locations. What it all boils down to is that the retail industry is highly competitive, and with the rise of e-commerce it is only becoming more so. Urban Outfitter's is struggling to find a successful formula for consistent performance in this climate.

Wasted share buybacks

Legendary investor Warren Buffett has always emphasized the importance of businesses returning capital to its shareholders over time.

Since the end of fiscal 2010 -- ending in January -- through the first nine months of fiscal 2017, Urban Outfitters' management has reduced the share count from 171.2 million to 117.4 million through share repurchases. These share repurchases have cost a total of $1.9 billion, or more than half of the retailer's current market value.

Stores are underperforming and growth is slowing, and this is caused by a lot of competition in the industry, which means there is not an easy solution to fix Urban's problem. If the business is generating more cash than management knows what to do with, it should distribute the excess cash back to shareholders through dividends.

Instead, management has poured $1.9 billion into a stock that has gone nowhere in seven years. Investors would have been better off investing that $1.9 billion in a S&P 500 Index fund or depositing the money in a bank account to collect interest.

URBN data by YCharts

Better alternative

A better alternative would be to swap Urban Outfitters for an industry staple like Nike. Athletic apparel is athletic apparel -- its core products don't change that much and it's less susceptible to fast-fashion. As a result, Nike has been delivering consistent earnings growth and dividends to shareholders for years.

It is possible Urban Outfitters' stock will eventually find a growth spurt, but when will that happen? If it takes Urban Outfitters too long to correct its problems, investors face the opportunity cost of holding an underperforming stock. Investors don't have to wait for Urban Outfitters to make a comeback.

If you are looking for a reliable retail investment, look for retailers like Nike that have demonstrated a consistent track record of revenue and earnings growth over many years.

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John Ballard has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Nike. The Motley Fool has a disclosure policy.