With stock prices getting beaten down, there must be a lot of bargains out there now, right? Maybe not. Some advisors, such as Merrill Lynch, caution investors to avoid declining stocks which may be perceived as good value but suffer from weak underlying fundamentals. By using a statistical model that analyzes pricing and momentum, brokerages can separate good value opportunities from value traps.
According to Investopedia, a “value trap” stock is one that is trading at low multiples of earnings, cash flow or book value – but for a good reason: the company‟s future is cloudy at best. What may appear like a bargain may never rise in price due to poor management, a lack of solid investor relations or an inability to differentiate itself from competitors.
Fund managers look for a catalyst to propel a stock into popularity, such as a new product release or reorganization; without a catalyst the stock will likely remain out of favor in managers‟ eyes.
Recent reports include industries that have been beaten down recently.
- Electronic Equipment & Instruments
- Energy Equipment & Services
- Independent Power Producers & Energy Traders
- Industrial Conglomerates
- Insurance Machinery
- Metals & Mining
Personal Products Savvy fund managers will typically not get in until a catalyst is to be announced. Senior advisor Nathan Threebes suggests following that approach when buying value.”Look for news that will propel earnings growth,” he says, “and be supported by operational fundamentals.”
In addition, he cautions investors to let the news play out in the
market before buying. “Value investors should not get caught up the initial „irrational exuberance‟ of trading news,” says Threebes. Some experts point out that value models like Merrill‟s may have flaws because they tend to analyze the short –term impact of the catalyst when value investing is more long term. Threebes adds that the cyclical nature of commodity based industries (like energy) makes long-term value predictions difficult. Although there may be some attractive names within the industries on Merrill‟s list, the economic environment may also limit short-term gains. Despite US moves to loosen credit, some sectors will likely see further decline in the coming months.
Bottom line: make sure your value picks are financially sound, well-managed companies that have real breakout potential.
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