Finally, the stock market and economy are doing noticeably better. Perhaps the most welcome sign is unemployment, which has gradually worked its way down to 8.5% from a recession high of 10.1% in October 2009. The S&P 500 has risen nearly 9% in the past three months and investors have been forecasting progressively less market volatility, as shown by a 35% decline in the Chicago Board Options Exchange (CBOE) Volatility Index during the past three months.

Not all the stocks that have been participating in the recent rally deserve to, however, because the companies they represent simply don’t have a very bright future.

Even though these stocks have been going up with the overall market, plenty of them could drag a portfolio down in the long-run. I wouldn’t recommend these stocks to anybody because they’re likely to seriously underperform and lose you money, even if there’s an extended bull market.

Office supply retailer Office Depot Inc. (NYSE: ODP) is such a stock.

Office Depot has already been a poor performer for many years, losing shareholders 18% annually for the past decade. Plummeting share prices haven’t created a great value play, as some might be tempted to believe, though, as it might for any number of solid companies like General Electric Co. (NYSE: GE), 3M Co. (NYSE: MMM) or Caterpillar Inc. (NYSE: CAT), just to name a few.

I think Office Depot is a stock to avoid at any price because the company no longer sits on a solid foundation. Sales, which have grown at an anemic 1% rate for the past five years, will contract by 1.5% annually for the next five years, analysts estimate. This is because about 80% of sales, currently $11.5 billion annually, are from small businesses, which were particularly hard-hit by the recession. Many are still in survival mode and could take a lot longer than larger companies to fully recover and resume normal spending. Exactly how much longer is almost impossible to accurately predict, but I wouldn’t be surprised to see the small business recovery drag out another four or five years, perhaps even longer.

Besides relying far too heavily on hurting small businesses for revenue, Office Depot lacks the scale, bargaining power and cost advantages of much larger competitors. Staples Inc. (Nasdaq: SPLS), for example, generates more than twice as much as Office Depot in annual sales — $25 billion in 2011. Staples’ operating margin of 6.4% in 2011 was markedly better than the 4.6% industry average and far superior to Office Depot’s nearly 1% operating loss.

This poor competitiveness stems from Office Depot’s inability to negotiate lower prices from suppliers the way bigger rivals can. And, Office Depot hasn’t managed to develop a thriving e-commerce business, which is cheaper to operate than traditional retail outlets. Staples, by contrast, has evolved to become the second-largest Internet retailer behind Amazon.com Inc. (Nasdaq: AMZN).

Considering the lack of major differences between competing products and the negligible cost for consumers to switch to another company’s products, low-cost providers like Staples and even part-time players like Wal-Mart Stores Inc. (NYSE: WMT) are best-positioned to gain dominance. A higher-cost, lower-margin operator like Office Depot, on the other hand, will likely lose customers and could even end up having to close stores, particularly in North America, where the office products market is saturated. In fact, the company has already been closing stores in the U.S. and Canada for several years — 121 in 2009 and 22 in 2010, for example — and is now down to about 1,200 retail outlets worldwide. I think layoffs and more closings are possible during the next few years because management will need to cut costs further to achieve and maintain positive margins.

Risks to Consider:  Since Office Depot’s downward spiral appears likely to continue, shorting the stock may seem like a no-brainer. Short sellers could get burned, though, if the stock reverses course for some reason, like small businesses recovering more rapidly than expected or swift action by management to improve profitability through deep cost cuts.

Action to Take –> Office Depot is a terrible investment I see treading water, at best, because of the competitive disadvantages I mentioned. However, it’s also easy to imagine the stock continuing its long decline, delivering another 8% to 10% a year in losses as it heads down to $1.80 or $1.70 a share from the current share price of around $2.80. And that estimate could be optimistic, since some analysts already value the stock at less than $1 per share. This seems reasonable to me when you consider investors have paid an average of 6.3 times earnings for Office Depot for the past 10 years. If you multiply that by 2012 estimated earnings of $0.05 a share, you get a share price of only $0.32 (6.3 x $0.05 = $0.32).

Even if Office Depot manages to get back in the black in the long-term (it has posted negative earnings for the past four years), it’s probably not going to offer Staples or other big rivals major competition any time soon. Eight or 10 years down the road, we might even see headlines about Office Depot filing for bankruptcy.

You may want to short the stock if you’re adventuresome, keeping in mind the risks I’ve described above, but I don’t see any other role for it in a portfolio. It’s probably not even worth holding as a takeover candidate, since high degrees of product overlap with the competition mean Office Depot doesn’t have much of anything new or complementary to offer potential buyers, except additional outlets. And even these wouldn’t be that great an asset since many retailers are moving toward smaller stores and more online sales.