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Screening for Possible Value Traps

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 (NYSE: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
NCR NCR Corporation 24.51 3630.6
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 (NYSE:CCL)

Hewlett-Packard Company (NYSE: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?

Rating: 3.3/5 (19 votes)



Adib Motiwala
Adib Motiwala - 6 years ago    Report SPAM
Maybe update the table to show annual drop in margins. Also please be specific about margins. Do you refer to gross margins or net or operating margins. There could be different issues at play. I think you are referring primarily to gross margins.
Superguru - 6 years ago    Report SPAM
“I would rather buy good companies at fair prices than buy fair companies at good prices.” Haven’t we heard this many times?"

I am more and more tending this buffet style of value investing only in solid companies.

I heard Chanos say HPQ has debt.

While all other good technology companies even RIMM is debt free and have good cash balanaces.

Also HPQ has been hiding the decline by acquiring other companies.

Remember IBM had a near death experience and its turnaround by Louis Gerstner was miraculous.

It will good to know why value gurus like HPQ. There is no good reason why HPQ may not have near death or death experience.

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