Falling into value traps is one of the biggest mistakes value investors make. Value traps tend to appear cheap, but their business internals are deteriorating – the business is destroying value. We are having a very good discussion about how to avoid value traps here. We pointed out that one of the obvious sign of a value trap is declining profit margins, as seen clearly from companies like Research-In-Motion (RIMM), Nokia (NOK) and RadioShack (RSH).
We will release a feature of “Warning Signs” which will warn you if a company has declining profit margins. Using our “All-In-One Screener” we did a simple screen for companies that are having declining profit margins in the technology and consumer service sector. The market cap of the companies is at least $1 billion. These companies have seen declining profit margins over the past five years:
|Symbol||Company||Share Price ($)||Market Cap (mil)|
|CVS||CVS Caremark Corporation||45.94||61576.2|
|CAH||Cardinal Health, Inc.||43.185||14715.1|
|OMC||Omnicom Group Inc.||50.09||13237.2|
|MAR||Marriott International, Inc.||36.77||12008.9|
|HOT||Starwood Hotels & Resorts Worldwide, Inc||51.11||10004.9|
|LUV||Southwest Airlines Co.||9.42||7251.1|
|CSC||Computer Sciences Corporation||23.85||3686.1|
|WEN||The Wendy's Company||4.77||1863.7|
|MTN||Vail Resorts, Inc.||49.8||1775.8|
|CAKE||The Cheesecake Factory Incorporated||32.4||1721.6|
|CAR||Avis Budget Group Inc.||15.32||1618.7|
|BGC||General Cable Corporation||27.7||1336.2|
|TXRH||Texas Roadhouse Inc||18.47||1276|
|JACK||Jack in the Box Inc.||27.55||1251.8|
Some of the margin declines are caused by the structural change of the business. The company may go through acquisition or spin-offs. Some of them do have long-term decline. A few examples here:
Cardinal Health Inc.
Carnival Corporation (CCL)
Hewlett-Packard Company (HPQ)
Renowned short-seller Jim Chanos has been shorting HPQ, saying it is a value trap. It does have the sign of it: long-term margin decline:
Will new HP CEO Meg Whitman turn it around? We don’t know, and that is again a “too-hard” question to answer. There are plenty of companies that are of higher quality and have sustainable profit margins. Why would we want to bet on it?
“I would rather buy good companies at fair prices than buy fair companies at good prices.” Haven’t we heard this many times?