What is a value trap?

[CY09]

3 out of the 4 China State Banks (ABC, CCB, ICBC) are potential test subjects if they are value traps.

Since the start of 2023, their price earnings ratio is below 5 and dividend yield is 8-9%. They are the top 3 in Tier 1 equity ratios, with price book less than 0.5. The banks are not oppressing OPMIs or giving them low dividends

To value investors, these 3 banks are intrinsically undervalued. However, are they value traps with worsening fundamentals as mentioned in Weijian's point 2? I wouldn't know, but as time progresses we will know if this story of a value trap among the China state banks is true

[thefarside]

Warren Buffett said there are only 2 important things in investing

1) how to value a business (or a stock)
2) how to think about market prices

My own understanding of value traps simply means those prices that an investor think the market should pay that stock never turn up.

The thing I have found isif the market is not giving a business what you perceive to be its rightful valuation, there are often valid reasons for the market to come to that decision. Sometimes the reasons could be as simple as the market needing proof and more information that the fundamentals can turn around. In this case if you have a different view of these fundamentals and these are businesses where those cash cash come out from better conditions, then its just a matter of taking the other side of the bet and waiting.

However there are more often than not the discounts are due to type of business and place these companies operate in which may mean those discounts exist forever because of real or perceived of structural handicaps. In this case, those discounts lasts forever - long enough for it to be not worth the trouble if you have better options on the table

[donmihaihai]

It is getting humorous.

If I picked the right stock and made some tidy profit, everything is good, otherwise if I picked them using some so-called value matrix, then that stock/company is a value trap. If I replace “value trap” with “I made a mistake”. the discussion will be way different and I don’t see a lot of such discussion or articles on making mistakes.

Ok let use value trap. And as a stock picker, my job is to pick the right stocks or avoid mistake(value trap) or get the ratio more rights than mistakes. So if I keep picking value traps, then I have a problem with my stock picking skill, isn’t it?

You can make it sound very simple just by never mention the word value trap again. And yes, I have never seen those superinvestors use the value trap. Maybe they did but I have never read it.

[i4value]

I think the value trap is about how you made the mistake. If you made a mistake determining the intrinsic value then it is a value trap. But if you made a mistake reading the market, is this a value trap?

[ghchua]

Hi thefarside,

However there are more often than not the discounts are due to type of business and place these companies operate in which may mean those discounts exist forever because of real or perceived of structural handicaps.  In this case, those discounts lasts forever - long enough for it to be not worth the trouble if you have better options on the table

The discount can last forever, but will the share price track the latest NAV of the stock? Let me give you an example. You bought at stock with a NAV of $1 trading at 70% discount to NAV at 30c per share. 15 years later, the stock NAV had increased to let's say $3, and applying the same discount of 70%, your stock is now trading at 90c.

Yes, the discount did not narrow for the stock above, in fact, it had remained the same at 70% from NAV. But share price had increased from 30c to 90c. Is it worth the trouble? I think it is.

[i4value]

Hi thefarside,

However there are more often than not the discounts are due to type of business and place these companies operate in which may mean those discounts exist forever because of real or perceived of structural handicaps.  In this case, those discounts lasts forever - long enough for it to be not worth the trouble if you have better options on the table

The discount can last forever, but will the share price track the latest NAV of the stock? Let me give you an example. You bought at stock with a NAV of $1 trading at 70% discount to NAV at 30c per share. 15 years later, the stock NAV had increased to let's say $3, and applying the same discount of 70%, your stock is now trading at 90c.

Yes, the discount did not narrow for the stock above, in fact, it had remained the same at 70% from NAV. But share price had increased from 30c to 90c. Is it worth the trouble? I think it is.

If I go by my definition, you have determined that intrinsic value to be $ 1 and the stock is trading at a 30% discount to the intrinsic value. It is a value stock. 15 years later the intrinsic value had increased and the market price had increased as well. From an investment perspective, you made money. It is not a value trap. A value trap is when you thought there is an opportunity to make money but you were wrong about the cheapness. Imagine the case where in 15 years time the intrinsic value is $0.90. You were wrong about its cheapness and as such it is a value trap.

Why are we talking about this? Because all value investing is about looking for bargains that are not value traps. If you are not clear, you will end up with wrong stocks

[weijian]

Hi thefarside,

However there are more often than not the discounts are due to type of business and place these companies operate in which may mean those discounts exist forever because of real or perceived of structural handicaps.  In this case, those discounts lasts forever - long enough for it to be not worth the trouble if you have better options on the table

The discount can last forever, but will the share price track the latest NAV of the stock? Let me give you an example. You bought at stock with a NAV of $1 trading at 70% discount to NAV at 30c per share. 15 years later, the stock NAV had increased to let's say $3, and applying the same discount of 70%, your stock is now trading at 90c.

Yes, the discount did not narrow for the stock above, in fact, it had remained the same at 70% from NAV. But share price had increased from 30c to 90c. Is it worth the trouble? I think it is.

hi ghchua,
$1 to $3 in 15 years ~CAGR of 13%. That is a decent company to start with so in practice, will it trade at 70% discount to NAV? If it does, Mr Market has probably priced in writeoffs in the future, or it doesn't really believe in the numbers. More often than not, Mr Market probably knows more than me. At least when I have seen a 70% discount, so far I also agree with Mr Market's valuation and eventually both of us have been proven right most of the time (eg. S-chips, some bombed out-or-going-to-bombed out REITs). So in the absence of a general crisis, the discount is attractive but the expected returns might be negative...Again, I am describing the norm and not the exception. I know there are exceptions (eg. Wheelock Properties's MBO is what I can easily remember off my head)

@donmihaihai
I see where you are going. There seems little difference using "value trap" or "making a mistake". But using the former may actually indicate that one has a higher tendency to absolve themselves of the loss, while the latter takes full ownership. Thanks for the great reminder once again.

[ghchua]

hi ghchua,
$1 to $3 in 15 years ~CAGR of 13%. That is a decent company to start with so in practice, will it trade at 70% discount to NAV?

Hi weijian,

I didn't make this up. It is an actual case study of a company listed on SGX. The company is Hong Fok Corporation. And yes, it is still trading at 70% discount to NAV.

[donmihaihai]

hi ghchua,
$1 to $3 in 15 years ~CAGR of 13%. That is a decent company to start with so in practice, will it trade at 70% discount to NAV?

Hi weijian,

I didn't make this up. It is an actual case study of a company listed on SGX. The company is Hong Fok Corporation. And yes, it is still trading at 70% discount to NAV.

Btw $1 to $3 in 15 years is a CAGR of about 7% rather than 13%. 7% p.a double in 10 year. $4 in 20 years. $3 in 15 years should be around 7%. 

7% CAGR is decent but not heart stopping exciting. Nice tip still. And I like reading comments like the company is performing but share prices doesn't, this tell me where to search and the state of mind of the person. Anyone who is in local market for last 20 years will know, there was or still is compression of valuation for at least last 10 years. And it last long enough for it to imprint into the minds. And just go by that thinking, if it goes on for another 10 years, valuation compressed by say another 30 to 50%, it will be the biggest bargain of my whole life, if it happened. 

There are not many opportunities like the one mentioned by ghchua. Alot of companies did not do as well. Surprisingly, many did not generate ROE of 7% but there are still a handful who are able to do it. Take the local bank as an example. Ignore last year, they were getting ROE of 10%++ on average over last 10 to 15 year and trade at 1 to maybe 1.5X BV thereabout. What kind of return one can get even without an expansion of valuation? Now think about when the environment allows these banks to generate 15% ROE and you are still looking at the same valuation. 

There are always strange opportunities or example out there.

[i4value]

All valuations are based on assumptions about the future. So when you look at valuation from an asset-based perspective and find that you have prices < NAV or other asset-based metric, the first question you need to ask is whether the assets are going to be written-down. If there is little chance of this, this you can safely use the asset value. So if you have "brick and mortar" companies trading at less that Book Value (where there is little chance of asset write-down), I won't consider these as value traps.