(FORTUNE Magazine) – FOR THE PAST FOUR YEARS a bunch of hip dudes who operate discount audio-video appliance stores played a fabulous gig with the cats on the Street. Between 1982 and 1986 they cut a long-playing record together: Compound growth hummed along at more than 25% annually, and a dozen companies went public to that Wall Street beat of expand, expand, expand. Says David Mondry, chairman and CEO of Highland Superstores, the second biggest of the national chains: ''You could do no wrong. Even an idiot could have made money then.''

Last year the record began to warp. While many companies boosted sales with new store openings, sales in existing stores lagged. Sales growth of electronic gadgets had slowed to about 10%, a figure that would not have most industries wailing the blues. But the top ten discounters had expanded their store space more than 25%. The charts aren't rockin' this year either; revenue growth is likely to subside to less than 5% industrywide. Profits are taking a pounding. Last year Highland's earnings fell 15% despite a sales increase of 26%, which came mainly from opening new stores. Federated Group, the fourth- largest discounter in the business, lost $5 million despite an 18% rise in sales. Even the group's best performer, Circuit City Stores, whose profits were up 60% on a 43% increase in sales, closed its 15 Lafayette stores in New York City because they were lackluster earners. Wall Street, characteristically, is rewinding the group's share prices. Since the second quarter of 1986, most publicly held discounters lost about half their market value. Says Wilfred Schwartz, chairman of Federated Group: ''There's no question that the industry is in turmoil at the moment.'' The turmoil peaked in June when the Brooklyn-born discount electronics firm known as Crazy Eddie revealed that the Securities and Exchange Commission was investigating the activities of its founder, Eddie Antar. Antar and First City Capital Corp. offered to take his $353-million-a-year company private for $7 a share. But in November 1986 he had dumped 1.5 million shares at $14 -- several months before Crazy Eddie announced a 90% plunge in fourth-quarter earnings. The SEC may want to know whether, when Antar sold, he knew something other investors didn't. Crazy Eddie's profits were pummeled in combat with such tough competitors as Newmark & Lewis, which had 18 stores, almost all on Long Island, and decided to move onto Eddie's block in the New York City market. Recently another offer for Crazy Eddie surfaced at $8. The audio-video discount business is in the middle of a classic phase of the retail cycle: one in which a jumble of high-growth, entrepreneurially managed companies will compress into a handful of well-run outfits. The main engine for rapid growth has been sales of videocassette recorders, a product that hit the mass market only five years ago. ''Our industry has never seen the likes of a fuel like the VCR,'' says Richard D. Lewis, CEO of Newmark & Lewis. ''Even the growth of television in the Fifties was not as explosive.'' Last year the industry sold 13.2 million VCRs, up from 4.1 million in 1983, reports the Electronic Industries Association, a manufacturers' trade group. Today Sam is playing it again and again in 45% of the nation's homes. The growth in sales has been accompanied by a rabbitlike proliferation of stores. In two years Newmark & Lewis, for example, has practically doubled from 25 to 44 outlets. Now the industry is caught in a squeeze: VCR sales are leveling off while prices are falling. At the same time, intense market wars are eating up profits in such other lines as microwave ovens and large appliances. Analyst Donald Trott of Dean Witter Reynolds likens the situation of the electronics crowd to the development days of the fast-food chains and discount department stores. Says he: ''In discount stores the leadership companies in the Fifties and early Sixties -- Korvettes, Two Guys -- went out of business because growing competition eventually put a lot of pressure on their operations and their margins. Most of the companies in the consumer electronics industries have also been large mom-and-pop operations. They are phase-one companies, and now we're heading into phase three.'' In this new phase even the most optimistic managers expect some attrition. Among the survivors, according to Trott, will be Best Buys, Circuit City, Federated, Highland, and Newmark & Lewis. The consumer electronics business is a two-headed monster that feeds on a growing economy and a stream of new products. For the past three years it had both. But VCR sales are likely to remain almost flat this year at 13.7 million units. That kind of volume is not so bad, but prices are dropping faster than Joan Rivers's ratings. ''Every time we think we hit bottom, it goes lower,'' lamented one buyer to This Week in Consumer Electronics, a trade magazine. The industry's runaway growth was fueled by all that cash raised in public offerings. ''Wall Street began beating the country to see how many companies it could throw money at,'' says Federated's Wilfred Schwartz. ''Now the industry is overfunded and overexpanding.'' Federated caught its bundle of public cash in 1983 and has almost quadrupled sales to $431 million and stores / to 66. Highland took investors' money in 1985 and ran its size up to 61 outlets from 33; another 11 are abuilding. Fretter Inc., Good Guys, Luskin's, Newmark & Lewis, and Tipton Centers were among the others to go public and start doubling. Most analysts say there is only room for two of these so- called power retailers in most markets. Economics of the business dictate that a chain must have a heavy presence in any local market it serves. Concentration provides economies of scale, particularly in advertising, which normally eats up 5% to 8% of sales. Highland, for instance, will have built 14 stores in Chicago in the two-year period ending next February. About 350,000 people support one store, so when a couple of these discounters butt into each other, the crash of falling prices can be loud. Highland is invading the Minneapolis and Milwaukee turf owned by Best Buy; Lechmere, a division of Dayton Hudson Corp., made a foray into Circuit City's Atlanta stronghold; Highland and Fretter will be slugging it out in Lechmere's New England home. New York City is an inferno of five chains and countless other local discounters. Even smaller markets are not immune. In 1986, Silo, now owned by Dixons PLC, the largest electronics retailer in Britain, blasted into the Portland, Oregon, area with four stores and a warehouse. When these retailing Goliaths hit town, there's not much room left for the local David. Circuit City and Federated both operate superstores that range from 20,000 to 35,000 square feet, the size of many supermarkets. These are known as destination stores, ones you decide to visit before you leave home. They are big enough to display lots of different models of every conceivable VCR, television, stereo speaker, or compact disk player. Many of these companies began life as dealers in white goods -- that is, refrigerators and dishwashers -- and they still sell these products as well. Circuit City has about 200 televisions on its sales floor, which is laid out in a racetrack format. A red linoleum path circles around the place to ensure that customers are directed into the various departments. The size of these marts and their huge inventories make them prisoners of sales volume. In order to be profitable, a store of 20,000 square feet usually has to generate about $10 million in annual sales, which is about twice the sales-per-square-foot ratio of the best department stores. That kind of volume can come only at a price -- low prices, in fact -- that yields average gross profit margins of 25% to 35% of sales and a net profit of less than 4%. Crazy Eddie's commercials scream his prices are insane, and it certainly doesn't take a lick of intelligence to cut prices. But it does take an enormous amount of logically channeled neurological activity to make a buck with such thin margins. One company that has not been thrown off its stride by price cutting is Circuit City, now the biggest company in brand-name consumer electronics. Over the past five years, the Richmond, Virginia, company's revenues have grown at an annual compound rate of 42%, and earnings growth is galloping along at 65% a year. Industry downturn or not, the company's sales from existing stores, a critical factor in judging the strength of its business, were up 18% in the fiscal year that ended this February. Circuit City had the good fortune, as it turned out, to outgrow its hometown market sooner than any of its competitors did and to be early in its expansion into other localities. Says Richard Sharp, president and chief executive: ''For years this company has run a dispersed business, so we had to develop control systems.'' The company trumpets Sharp's rise to the top job last June as the completion of its transition to professional management. His expertise is in so-called back-room systems, whereas his predecessor, Alan Wurtzel, was a member of the founding family and a terrific merchandiser. Before becoming president, Sharp completely revamped the company's distribution system. Circuit City's three warehouses are now totally automated. In the Atlanta warehouse, for example, about a dozen employees per shift handle merchandise worth $400 million. Sharp boasts that Circuit City is the industry's low-cost retailer, a status that allows it to compete aggressively with anyone. Indeed, the company's advance into Los Angeles was unprecedented. Since November 1985, Circuit City has built 19 stores and claims to have more than 15% of the market, twice the share of its nearest competitors. MANY OTHER discount chains have fared less well with their incursions into new markets. Federated launched a major expansion into Texas in December 1984, hoping to stake a big claim in that huge market. But Highland, which built 18 stores, and Tandy Corp.'s McDuff chain, which now has 41 stores in the Lone Star State, have similar ideas. Needless to say, with its oil economy recently in shambles, Texas has been an electronic dry hole. Tandy's Radio Shack, headquartered in Fort Worth, is the leading private label in the business. With McDuff, Tandy is tuning in to the name-brand business. In 1985 it acquired the 24 stores of Memphis-based Scott-McDuff Corp. and a chain called Video Concepts from Jack Eckerd Corp. Since then the company has also expanded McDuff's into Denver, Kansas City, San Jose, and Tampa, following a marketing strategy that is a variation of Radio Shack's effort to intercept customers at every corner. McDuff has 168 small stores in shopping malls that mostly sell big-screen TVs and VCRs, and 121 large stores that hawk the entire product array of audio and video equipment. The mall stores give Tandy a shot at a captive audience; the big stores generate the high volume and buying power needed to keep the prices at both places low. ''Our aspirations are to be the player in name brands,'' says Clint Thomas, the division president. Though McDuff is expected to do $400 million in sales this year, competitors wonder if Tandy can keep the volume turned up. While the company is a private-label power, it has yet to build consumer clout as a name-brand merchant selling goods it buys rather than makes. This is not the first time the discount consumer electronics industry has overloaded its circuits. In the recession of 1981-82, nearly half the audio dealers were wiped out, and three of the biggest -- Tech Hifi, Schaak Electronics, and Pacific Stereo -- were fatally wounded. They too were the victims of their own success. In the Seventies, Japanese audio components were flooding the market, and all those baby-boom kids were going to college and demanding stereos. The combination created cash mountains for once sleepy hobby shops. ''Electronics retailers felt better about themselves than they should have,'' recalls Sandy Ruby, former chief executive of Tech Hifi. Ruby started the company with John Strohbeen, a fellow MIT student who is now president of Ohm Acoustics Corp., a popular loudspeaker manufacturer. ''In the glory days of audio we were modestly successful businessmen buoyed by a tidal wave. It would have been a very unusual person to think he was not touched by some kind of magic.'' The magic vanished with the recession and the suicidal margins that discounters accepted so as to maintain sales volume. The industry was bailed out the last time by the arrival of the VCR, and to a lesser extent, the microwave oven. Wilfred Schwartz of Federated firmly believes that technology will refloat the industry this time too. The company, which runs some of the more glamorous stores in the business, loaded up on VCRs before they got hot, and prescience paid off. Federated, says its president, Keith Powell, was also early on disk players and camcorders, and now is building its stock of personal computers. Schwartz thinks that such products as personal facsimile and copying machines for the home office may become as common as radios when the price drops. He is praying that will be soon. BUT THE CROWDED new environment is forcing all the companies to think more about managing and less about merchandising. Mastering such operational aspects of the retailing business as management information systems and warehousing is vital. Family-run chains are hiring MBAs and delegating responsibility to these mercenaries. Says David Mondry of Highland: ''When we had our arms around the business, if there was a problem 100 miles away, you got into the car, drove there, and said, 'What's going on here, folks?' Managing the remote locations has been much tougher.'' Mondry, whose family controls Highland, might not hire himself these days. Neither he nor his brother Eugene, who is president of the chain, has a formal business education. Their sons work for the company, and have advanced degrees to go along with growing up in the business. As competition in the industry intensifies, there is likely to be more blood on the showroom floor. But the discount audio-video appliance retailers have clearly and permanently staked out a position for themselves as mass marketers. ''This is not the catalogue showroom industry,'' says Schwartz. ''This is not a fad.'' At the beginning of the decade, the combined sales of the top ten name-brand merchants came to less than $1 billion a year; next year there could be a few billion-dollar companies. For investors the electronics dealers offer ample evidence of the astonishing speed at which new forms of retailing develop these days. A huge opportunity for new players opened in consumer electronics, but it existed only for a few years. And unlike a videotape or a compact disk, it cannot be replayed. Where in retailing will the lightning strike next?

CHART: COMPANY DATE OF AMOUNT PRICE RECENT PUBLIC RAISED PER SHARE PRICE OFFERING in millions

Audio/Video Affiliates 7/17/84 $9.7 $4.88 $6.75 Best Buy 4/15/84 $8.1 $4.50 $14.75 Circuit City 12/12/61 $.5 $.20 $39.25 Crazy Eddie 9/13/84 $11.8 $2.00 $6.00 Federated Group 11/15/83 $9.6 $8.33 $4.75 Fretter 5/7/86 $34.8 $16.00 $5.00 Good Guys 2/6/86 $9.3 $14.00 $4.50 Highland Superstores 5/9/85 $52.5 $18.50 $10.50 Luskin's 6/3/85 $3.7 $14.50 $4.00 Newmark & Lewis 6/27/85 $8.9 $8.00 $8.25 Sound Advice 6/27/86 $3.7 $7.50 $5.00 Stereo Village 5/11/84 $1.4 $4.00 $.50 Tipton Centers 7/11/86 $10.0 $15.00 $6.00

CREDIT: NO CREDIT CAPTION: A shower of money -- then a market bath Over a two-year period, many discounters were led to the public trough by enthusiastic underwriters. As retailers' profits waned, so did their stock prices. DESCRIPTION: See above.