Value Trap Warning Signs

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:

  1. The business is still struggling at the peak of its operating cycle.
  2. Company management compensation structures haven’t changed in the face of the stock’s declining performance.
  3. 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.”
  4. The company is losing market share.
  5. There are powerful external stakeholders—unions and governments, for example, can “hold real sway in many large public companies.”
  6. The company’s capital allocation process is unclear or unchanging.
  7. The process for evaluating line managers is inflexible.
  8. Management has “failed at the majority of prior-year goals” and/or near-term goals are unachievable.
  9. The company balance sheet reflects more leverage than it can sustain through a “‘multiyear turnaround.”
  10. Strategic vision is “cloudy.”
  11. 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.”
  12. Activist investors don’t show any interest. “In the end,” the article concludes, “any good value story with non-lethal problems” should attract them.