Know the difference between a value stock and a value trap. The dip in the U.S. stock market in the past two months has provided market bulls with an opportunity to load up on some…
Know the difference between a value stock and a value trap.
The dip in the U.S. stock market in the past two months has provided market bulls with an opportunity to load up on some of their favorite stocks at discounted share prices. Long-term value investors are searching for the best market deals to buy on the dip, but it’s extremely important to understand the difference between a value stock and a potential value trap. Sometimes, value traps are difficult to definitively identify, but there are certainly red flags that investors can avoid. Here are seven value stocks that may end up to be value traps for investors.
General Motors is a controversial stock for long-term investors. GM certainly has some high-profile bullish backers, such as Warren Buffett. However, the company is also adjusting to a technological shift in the auto industry and a potential long-term cyclical decline in auto sales. GM’s forward earnings multiple of 6.3 percent is among the lowest in the S&P 500 index, but there are also plenty of red flags. Revenue is down 5.8 percent over the past five years, and earnings per share growth has been negative in three of the past five quarters.
Viacom is also dealing with disruption in its traditional cable TV business. On the surface, Viacom’s 8.2 earnings multiple and solid 2.5 percent dividend make the stock seem like an excellent value, but the company’s business outlook is potentially troubling. Cord cutters have been abandoning cable TV in droves, a trend that is reflected in Viacom’s 5.3 percent drop in revenue over the past five years. Viacom is also expected to generate only about 3 percent earnings growth in 2019, less than half of the projected earnings growth rate of the S&P 500.
Goodyear has an earnings multiple of 6.9, exactly the type of number value investors like. Unfortunately, a glut in the global tire market has been weighing on tire prices and margins, and those pressures have been reflected in Goodyear’s underlying growth numbers. Revenue is down 19.8 percent in the past five years, and EPS growth has been negative in five of the last six quarters. In the longer term, Goodyear may struggle to sell as many replacement tires as innovation extends the life cycle of tires and autonomous vehicles improve driving efficiency.
IBM has been such a well-disguised value trap in recent years that it even fooled Buffett, who unloaded his IBM stake earlier this year, reportedly at a steep loss. Sure, IBM has a compelling 9.8 earnings multiple, and bulls are confident in the long-term prospects for its cloud services and artificial intelligence segments. However, IBM has yet to demonstrate that growth in these areas can offset losses in others. Revenue is down 18.9 percent in the past five years, and tepid EPS growth has maxed out at 4 percent over the past two years.
Macy’s has held up relatively well compared to department store peers such as Sears Holdings Corp. (SHLDQ) and J.C. Penney Co. (JCP). However, despite its best efforts to beef up its online sales game, Macy’s is still struggling to grow. Macy’s stock has an earnings multiple of 9.3, but revenue is down 7.9 percent and free cash flow is down 34.9 percent in the past five years. Looking ahead to 2019, analysts are forecasting another 13.9 percent drop in EPS and only about 0.4 percent revenue growth, according to Yahoo.
Qualcomm has had a crazy 2018. Its merger with Broadcom (AVGO) was blocked due to national security concerns, and it subsequently abandoned its buyout of NXP Semiconductors (NXPI). Qualcomm has since committed its cash flow to a new $30 billion share buyback program. With a forward earnings multiple of 11.5, QCOM stock may look like a value. However, revenue is down 10.7 percent in the past five years, and free cash flow has dropped 63.5 percent. Qualcomm has reported negative EPS growth in five of the last six quarters.
General Electric has become one of the most polarizing stocks on Wall Street. With shares down 58 percent year-to-date, GE’s forward earnings multiple has dropped to 8.9. GE stock may look like a bargain for a blue-chip industrial giant, but EPS is down 55.4 percent in the past five years, and revenue dropped 4 percent in the most recent quarter. Add in two dividend cuts, multiple credit and analyst downgrades, three different CEOs over a two-year stretch and no clear progress on a long-term turnaround strategy, and GE stock doesn’t quite look like a value.