VALUE TRAPS

"Never buy what you don’t want, because it is cheap; it will be dear to you." Thomas Jefferson 1825

"I think that it’s easy to avoid value traps. The trick is to stay away from companies that can’t grow their cash flow and increase intrinsic value. If I think the business is a ‘melting ice cube’ like newspapers, yellow pages and video rentals, to name a few bad businesses, then I won’t invest in it, no matter how cheap it is.” Kevin Daly

"One of the biggest dangers in value investing is falling for the formerly high-quality business that is getting slightly less high quality every day. With all the disintermediation going on, that’s a bigger risk today than ever." Ricky Sandler

“I know that one person’s “ostensibly low valuation” is another’s moribund value trap.” Nick Train

“If the value isn’t growing, then you’ve got a clock that’s ticking against you." Bill Nygren

“Predicting the range of possibilities for the intrinsic value, and ensuring a significant upward skew to that range, is the most important work we do. As a dear friend recently told me, he measures value and his margin of safety on the X-axis, rather than only the Y-axis. What he meant is that while most value investors only measure their margin of safety by the discount they are paying to current fair market value, a very important risk consideration is the slope of the curve of that intrinsic value. If that intrinsic value is unchanging over the course of years, you are invested in a value trap.” Steven Wood

“Low price is very different from good value, and those who pursue low price above all else can easily fall into ‘value traps,’” Howard Marks

“The best way to avoid a value trap is to ask the obvious question; ‘if this stock is so cheap, why is it cheap?’ The cheaper it is the more the market is telling you there is something wrong. If that’s the case and you’re still intrigued, you better dig really deep”. Preston Athey

"If the industry is subject to rapid and unpredictable change and we can’t reasonably understand where the business will be in five years, we should move on to the next idea. That discipline alone goes a long way toward avoiding value traps." David Green

“I’ve never felt that there is any such thing as a value trap. They are investing mistakes but I don’t think they are value traps. If an investment flat lines or declines on you, people have a cute way of saying it’s a value trap. If you were intellectually honest, you would fine a proper reason for why things didn’t work out.” Mohnish Pabrai

“Value traps are cheap for a reason - perhaps an inept and entrenched management, a poor history of capital allocation, or assets whose value is in inexorable decline.” Seth Klarman

“Value Traps: some common characteristics .. cyclical and/or overly dependent on one product, hindsight drives expectations, marquis management and/or famous investor(s), appears cheap using management’s metrics, accounting issues.” Jim Chanos

“The question in avoiding a value trap is two fold. First, are the dominant shareholders or management incentivised to have some kind of transaction that’s going to increase the market value of the company in the near future? And second, is the intrinsic value of the company increasing at a relatively attractive rate of return?” Paul Issac

“You have to recognise if a disruptive technological or structural industry change is underway or relative value will point you to a lot of value traps. We always asking whether there’s a transitory disruption to a business or whether there’s a point of discontinuity, as was the case with Kodak.” Brian Barish

“To avoid potential value traps, we also filter our companies where the 10 year trend in cash flow as a percentage of sales or per fully diluted share is negative.” Bernard Horn

"Part of the process is meant to identify potential value traps. We do that in a variety of ways, but key among them is reconciling the income statement to the cash-flow statement to identify permanent or semi-permanent shortfalls in cash flow relative to earnings." Joe Huber

"Given that value traps often result from companies squandering your capital, we put a lot of emphasis on management’s capital-allocation prowess. That involves understanding how they make capital allocation decisions as well as their track record thus far in doing so." David Green

"To combat value traps we build in formal devil’s-advocate reviews of our holdings on a regular basis, including right off the bat when new ideas are presented. There’s a natural tendency in investment research to gravitate over time to one side of the story or the other. We think it’s critical to keep both sides front and center from beginning to end." Clyde McGregor

"Starting out I was a Graham and Dodd investor, focused on low price/earnings ratios, good balance sheets and high dividend yields. The problem with that is you can get caught in too many value traps. I concluded I was better off focusing primarily on two key variables in weighing investment attractiveness: company valuation and business quality." David Herro

"I don't use the term ‘value trap’. I find it more helpful to say, ‘okay, I didn't understand a component of this, so it's not working out’. Generally, if you're right in your analysis, including understanding the incentives of the company's leadership, then most of the time the market will agree with you in two or three years." Ken Shubin Stein

"You make your profit in stocks between reality and perception. If we think the reality is X and the market's perception is Y, we want to have a clear view on what's going to change the reality or the perception that is going to cause the earnings to increase, the multiple to expand and the stock price to go up. That's how we try to avoid value traps." Eric Marshall

"Relying purely on a reversion to the mean can lead to a lack of understanding of the underlying business dynamics in an industry or company, making an investment more susceptible to 'value traps' and long term value destruction." Marathon Asset Management

"When I think about the history of my mistakes (and it’s a long history), those mistakes have generally been when the investment was in a business that was ostensibly very cheap, but where you had secular headwinds, and those headwinds led to the undoing of the thesis. When I look back on the investments that I sold at a loss, they were bought at a very low valuation. But that valuation was not enough to discount fully what was to come, which was a demolition of EBITDA and free cash flow." Chris Mittleman

“One stock does not become a better value than another simply because it declines more in value, and ‘cheap’ statistical valuations can turn out to be far more expensive than they appear - especially at inflection points when past patterns of behaviour can undergo permanent shifts. In recognition of these realities, we are intently focused on revisiting our thesis and assumptions with as open a mind as possible.” John Harris

"Many of our mistakes have been where we thought we bought something with a significant margin of safety while knowing that it might be a melting ice cube. We thought it might weaken, but not for a long time out. But then it accelerated a lot faster than we thought it would. That's one of the big lessons we've learned over the last five years." Christopher Begg

"In my view, it’s easier to adopt this ‘I don’t know’ ethos by focusing on the business first and valuation second, as opposed to the other way around. I’ve found that when valuation is the overriding driver of interest, I’m prone to get involved in challenging businesses or complicated ideas and liable to confuse a statistically cheap price with a margin of safety." Allan Mecham

"When you find a ‘cheap’ stock, you can easily convince yourself that the long-term prospects of the company are great. That is why I try not to look at valuation at the beginning of the process. Cheap is not cheap when you hope for an increase of the P/E ratio in the short-run even though the long-term economics may be poor." Francois Rochon

“‘Carrying low valuation parameters’ is far from synonymous with ‘underpriced.’ It’s easy to be seduced by the former, but a stock with a low p/e ratio, for example, is likely to be a bargain only if its current earnings and recent earnings growth are indicative of the future. Just pursuing low valuation metrics can lead you to so-called ‘value traps’: things that look cheap on the numbers but aren’t, because they have operating weaknesses or because the sales and earnings creating those valuations can’t be replicated in the future.” Howard Marks

“We try to avoid value traps by not making valuation the first, second, or third thing we look at. We never base our thesis on valuation alone. For us it's about the size and durability of the moat, opportunities to reinvest in growth, cash flows and balance sheet, and management's execution and capital allocation. If a business isn't executing well or is making questionable allocation decisions, it is time to sell. We try not to say, ‘but it's cheap.’ When you are analyzing your portfolio and opportunity costs, if the only thing your thesis rests on is ‘it's cheap,’ then it is time to move on. You don't have to make money back the same way you lost it.” Dan Davidowitz

“We look first to identify the companies we’d be willing to invest in, then we do our valuation work. Starting with a rank-order valuation screen is more likely to lead you into less than-optimal businesses, which we can’t afford to be in with such a concentrated portfolio.” Brian Bares

"I used to spend a lot of time screening the market according to typical value criteria such as price to book or P/E, but I now do this a lot less often. I find that these types of screen naturally direct you to cheap stocks, whereas what I am looking for are value stocks. The two things are not the same. I much prefer to make the first cut according to whether a company has a wide moat as the time is unlikely to be wasted." Robert Vinall

“As a young analyst, I always started by looking for really cheap stocks, and after concluding they were indeed underpriced, I then tried to convince myself that neither the businesses nor managements were bad enough to offset the statistical cheapness. Having completed all the valuation work before even meeting the management, you can guess how strongly biased I was to conclude that they were at least acceptable! Today, I encourage our analysts to reverse that process: Find businesses and managements they’d be excited to own and then do the work to see if the valuation is attractive. If it isn’t attractive now, monitor the stock price so you are prepared to act when it is more attractive.” Bill Nygren

“If anything, we are less likely to look at something that sells at a low relationship to book than something that sells at a high relationship to book, because the chances are we’re looking at a poor business in the first case and a good business in the second case.” Warren Buffett

“We want to avoid value traps like the plague. That’s when you get down to the execution of value investing. Value investing works really well when it is well executed. But you can’t be superficial. You can’t just say it’s got a low PE, or a high dividend yield. Those are dangerous things.” CT Fitzpatrick

“People can get wrong is that a low valuation always indicates the best value. The stocks of companies that have taken on too much credit or interest-rate risk can for a time look very inexpensive. When the tide goes out, as it inevitably does, what looked like a cheap stock can look like anything but that fairly quickly.” Chris Davis