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How to Spot a Value Trap: Research In Motion

Question: When looking at cheaply-priced stocks, how do you know which ones are solid value stocks and which ones are dreaded value traps?

Answer: The value stocks eventually recover, whereas the value traps do not.

I realize that my answer is no more useful than Will Rogers’ advice to “Buy stocks that go up; if they don’t go up, don’t buy them,” and that is precisely my point. There is no systematic way to recognize a value trap.

Some sectors are more prone to value traps than others, and this is something I’ll elaborate on later in the article. But first I’ll give an example of a value trap that ensnared yours truly — BlackBerry maker Research In Motion (RIMM).

When I first started considering RIMM last July, it was one of the cheapest companies in the world. At one point in time it traded for just three times earnings and barely half its book value.

My thinking when I bought RIMM was straightforward enough. While the company was losing the smart phone war to Apple (AAPL) and Google (GOOG), it had a strong and growing services business with sticky revenues, a strong and growing presence in emerging markets, and a rock-solid balance sheet. Yes, the company was losing market share, but its sales were still growing and a decent clip. At the price at which it traded, RIMM didn’t have to win the smart phone war in order to be a good investment; it merely had to survive.

In most industries, this would have been sound thinking and the makings of a great contrarian investment. But in technology, where platforms are everything, it doesn’t hold. Much like the Game of Thrones, with technology platforms you win or you die.

Shrinking market share for your platform begets further shrinking market share. Retailers don’t want to take up shelf space better used for more popular products. Carriers don’t want to offer incentives. Programmers don’t want to write applications for a shrinking platform. Rather than a gentle decline, you get a sudden collapse.

Case in point, RIMM. With the BlackBerry, RIMM invented the smartphone as we think of it today and quickly rose to dominance. After conquering the corporate and government markets, the success of the BlackBerry spilled over into the consumer market. BlackBerries became known as “CrackBerries” for their addictiveness. As recently as 2010, RIMM held nearly half of the smartphone market, only to see that market share shrink to single digits today.

Believe it or not, I do believe that RIMM has a future. But its future lies as a software and services company, providing enterprise e-mail, messaging and security, and not as a hardware maker. A slimmed down services-only RIMM would be worth owning at the right price. But before that happens, management will likely destroy quite a bit more value attempting to salvage their hardware and operating system.

Not all cheap tech companies are value traps, of course. Microsoft (MSFT) and Intel (INTC) have both been cheap for years, though both have strong underlying businesses nearly impervious to competition and both have been rewarding shareholders with a high and growing dividend.

As much as we would like for it to be, this is not an exact science, and you’re not going to get it right every time. In the end, the best defense against a value trap is emotional discipline. Look at your investments critically and don’t make excuses when they fail to perform. Use stop losses when appropriate. And be honest with yourself when you ask the question, “If I didn’t already own this stock, is this something I would want to buy today, knowing what I know?”

Oh, and follow Will Rogers advice about avoiding stocks that don’t go up.

Disclosures: Sizemore Capital is long INTC and MSFT. Alas, we were formerly long RIMM.

About the author:

Charles Sizemore
Charles Lewis Sizemore is the Editor of the Sizemore Investment Letter premium newsletter and Chief Investment Officer of Sizemore Capital Management.

Mr. Sizemore has been a repeat guest on Fox Business News, has been quoted in Barron’s Magazine and the Wall Street Journal, and has been published in many respected financial websites, including MarketWatch, TheStreet.com, InvestorPlace, MSN Money, Seeking Alpha, Stocks, Futures, and Options Magazine and The Daily Reckoning.

Visit Charles Sizemore's Website


Rating: 3.8/5 (13 votes)

Comments

superguru
Superguru - 1 year ago
Yes, NOK and SONY are other examples. In technology, much higher % of deep value stocks are value traps.
pravchaw
Pravchaw premium member - 1 year ago
Wan't Apple a value trap at one time?
batbeer2
Batbeer2 premium member - 1 year ago
@pravchaw

LOL

Excellent point!
superguru
Superguru - 1 year ago
Turnaround of Apple and IBM is legendary. What % of such companies are able to turnaround as Apple (Steve Jobs) or IBM (Louis Grestner) did?

But if one of these RIMM, NOK or Sony turnarounds return could be phenomenal return.

Nok does not seem to have a very impressive leader. I do not know about Sony leadership. RIMM is a bet on its cofounder's genius.
kfh227
Kfh227 premium member - 1 year ago
I won't get into details. But I am long RIMM. Actually, I have less money invested in RIMM with a higher reward. I own RIMM via call options.

Why? If RIMM fails, does it matter that I had options instead of stock? If RIMMs BB10 is a success, why should I only quintuple my investment with stock when a much, much greater gain can be had.

Anyway, everything I hear about BB10 is amazing. The user experience is going to make iPhones and Droids look prehistoric (in technological terms). With proper advertising in the US (a small market!) a turn around could occur.

The negativity of RIMM in the US is amazing. Consider this. Mutual funds typcailly buy/sell most of hte stock in the US. You work at one. Would you consider telling your boss to buy RIMM? Or APPL?
AlbertaSunwapta
AlbertaSunwapta - 1 year ago
To me, much of the conventional thinking on what is and isn't a value trap has to do with people's inherently short term outlook. If they buy a stock and it doesn't recover or worse, falls further in a year or two, it's deemed to be a value trap, period.

Personally, I think some factor related the nature of the business (typical of that sector, peak earnings vs trough earnings, or whatever) needs to be considered. For instance, commodities often go through longer bom bust cycles, but in recovery returns for surviving companies might more than compensate for many years of substandard returns. Thus, call options might be very risky approach to capturing potential value.

For high tech, with little to no moat and rapid obselesence, high bankruptcy rates, non-salvageable book values, etc., a shorter term perspective might be more representative of the odds of favorable outcome. Thus call option might be a more reasonable approach.
robbieboggie
Robbieboggie premium member - 1 year ago
95% of all car manufacturers use QNX and 60% of all cars on the roads currently operate on QNX.

What is 5% of the car market worth?

What does QNX power that you use in your every day life... http://www.qnx.com/company/30ways/

QNX was open source today it is owned by RIM.

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How to spot a bubble. Go to a concert with Tiesto. Look at all the kids with iPhones. 95% of all kids already bought one. Who is the sucker here? Then you think about the Real Estate bubble or any other bubble the last 100 years and you may start making money in the market. When you see the herd, Wall Street, the news etc running in one direction. Be afraid, be very afraid and run.

People bashing RIM are the same people that were long the Banks in 2008 and told you to hold on. Now they are telling you not to touch them.

"Money is made in the market by betting on what is not obvious." George Soros

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