Today’s high stock market valuations make cheap stocks attractive, but a recent Bloomberg article warns that the market is “littered with ‘value traps’—stocks that look cheap but never substantially rebound.”
The article provides 12 value trap warning signs, as follows:
- The business is still struggling at the peak of its operating cycle.
- Company management compensation structures haven’t changed in the face of the stock’s declining performance.
- The company “dominates a smaller U.S. city. Managers have to live somewhere, and if that location is full of like-minded people, then change is harder to execute.”
- The company is losing market share.
- There are powerful external stakeholders—unions and governments, for example, can “hold real sway in many large public companies.”
- The company’s capital allocation process is unclear or unchanging.
- The process for evaluating line managers is inflexible.
- Management has “failed at the majority of prior-year goals” and/or near-term goals are unachievable.
- The company balance sheet reflects more leverage than it can sustain through a “‘multiyear turnaround.”
- Strategic vision is “cloudy.”
- The company’s CEO and board chairman are the same person—managing a board can take between 25% and 40% of a CEO’s time, while “deeply entrenched value traps are by their nature corporate turnarounds, whether the boss realizes it or not. They need 100 percent of senior management attention.”
- Activist investors don’t show any interest. “In the end,” the article concludes, “any good value story with non-lethal problems” should attract them.