Beware of value traps! Learn how to identify the warning signs of value traps when investing in shares.

What is a Value Trap?

A value trap is a stock that is bought cheap gets cheaper… and cheaper. A stock appears to be cheap but in reality the deteriorating price is a warning of changed business fundamentals and can indicate further deterioration.

 

Value Trap Indicators

Business Plan

  • Business plan changes, over complexity or failures blaming everything and everyone except themselves.
  • Unprofitable expansions into non-key competency / non-synergistic areas.

Management

  • Insider selling knowing bad news before it becomes public.
  • Overly high compensation for managers affecting company profitability.
  • Little value being delivered for expansion or to stakeholders.

Obsolete Technology

  • Fintech disruptions.
  • Product/service becoming obsolete/outdated.
  • Non-monopoly products/services being replaced by a better performing competitor.

Hidden Problems

  • High amount of cash but low interest income.
  • Frequent rights issues raising capital for non-legit reasons.
  • Shares buybacks, often at high prices, camouflaging company earnings and other issues.
  • Fraud, legal issues, or massive fines causing a dent on the company’s reputation and profits.

One Off Items

  • A large one time gain (or impairment) skewing the numbers for a quarter or financial year.
  • Not sustainable long-term advantages.

Balance Sheet

  • Overly high amount of borrowings causing the company to bleed paying just the interest on debt.
  • When a downturn (eventually) happens, will be one of the first casualties.

Industry Overcapacity

  • Overly high competition eroding profitability.
  • Frequently in industries with low barriers to entry and little product differentiation.
  • Affected by competitors who can produce in significantly larger quantities at cut-throat margins.

 

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Are we seeing many Bursa Malaysia stocks in a value trap situation in today’s market?