11 signs of a stock value trap
The historically high priceto-earnings ratios being placed on equities today make cheap stocks even more alluring.
But the market is littered with value traps — stocks that look cheap but never substantially rebound. So, here’s how to tell if you own a value trap: 1. The firm’s at an operating cycle peak and still troubled. After over seven years of economic recovery, most public companies should be showing strong earnings. 2. Management pay structures haven’t changed as the stock has declined/underperformed. 3. The business keeps losing
market share. 4. There are other powerful stakeholders. Unions and governments hold real sway in many large public companies, for example. But if return on shareholder capital must fight with other entrenched interests, change will be slower. 5. The capital allocation process isn’t changing fast enough, or is unclear. Many value traps still have decent current free cash flow. The trap comes from not using that capital efficiently to reinvigorate the business. 6. The company isn’t changing how it evaluates line managers. For a company to escape value trap status, it must change its operational DNA. 7. Management’s near-term goals aren’t achievable and/or it’s failed the majority of prior-year goals. Value stocks are a good investment when operational results improve according to a predetermined management plan. 8. The company has more financial leverage than it can sustain through a multiyear turnaround. Debt is the trigger for the most deadly value traps, snapping shut before management can turn things around. 9. The strategic vision is cloudy. Value traps almost always suffer from fuzzy management strategies. 10. The CEO and chair are the same person. CEOs likely spend 25% to 40% of their day managing their board. Deeply entrenched value traps are by their nature corporate turnarounds. 11. Even activist investors stay away. Any good value story with nonlethal problems should attract activist shareholders. –