Among U.S. companies, Leucadia National (Trades, Portfolio) Corp. (LUK, Financial) has declining profit margins and a weakened financial outlook. As the beef-processing company shows warning signs of potential bankruptcy, several gurus look elsewhere for growth and value.
Brief discussion about the warning signs
About four years ago, GuruFocus released the Warning Signs feature, which highlights key characteristics of a company’s financial strength, profitability, growth and valuations. The warning signs for each company are conveniently displayed underneath the company’s predictability rank, current stock price and average volume. These warning signs are color-coded similar to that of a traffic light configuration: green, orange and red indicate good signs, medium warning signs and severe warning signs.
To determine which industries have high downward potential, we can first compute the net warning signs for each company using the following formula:
# of net warning signs = 2 * # of severe warning signs + # of medium warning signs - # of good signs
We can then average the number of net warning signs for each of the industries to identify the weak industries. Based on the statistical analyses, real estate companies generally have the highest number of warning signs, suggesting that the real estate sector has the lowest value potential among the sectors. Additionally, the real estate sector has the highest sector Shiller price-earnings (P/E) ratio as of Sept. 30.
The distribution of average net warning signs across industries is roughly symmetric with a median near 4.17 and a standard deviation of 1.75. About 80% of industries have three to six net warning signs on average.
| Bin | Avg Net WS | Percent |
| 0 | 0 | 0.00% |
| 1 | 4 | 2.78% |
| 2 | 9 | 6.25% |
| 3 | 21 | 14.58% |
| 4 | 31 | 21.53% |
| 5 | 41 | 28.47% |
| 6 | 21 | 14.58% |
| 7 | 6 | 4.17% |
| 8 | 7 | 4.86% |
| 9 | 3 | 2.08% |
| 10 | 0 | 0.00% |
| 11 | 1 | 0.69% |
| Average Net WS | |
| Mean | 4.24 |
| Standard Error | 0.15 |
| Median | 4.17 |
| Mode | 4.50 |
| Standard Deviation | 1.75 |
| Sample Variance | 3.08 |
| Skewness | 0.49 |
| Range | 10.46 |
| Minimum | 0.11 |
| Maximum | 10.57 |
| Count | 144 |
Declining margins suggest value traps;Ă‚ gurus look for alternates
The “Margin Declining Value Traps” screener lists the companies that have the following characteristics:
- Since we want to look for value traps, we will only consider the companies with relatively low valuation ratios:
- A trailing-12-month P/E ratio less than 14.
- A price-book (P/B) ratio less than 2.
- A price-sales (P/S) ratio less than 2.
- Additionally, the company has an operating margin growth rate less than -5% and a gross margin growth rate less than -3%.
- We will only consider the companies that have a market cap of at least $1 billion and do not trade on the over-the-counter market.
Seventeen companies, including Leucadia, made the screener as of Sept. 30. As discussed in a previous article, Leucadia has five severe warning signs and three medium warning signs. Based on the above formula, the company has 13 net warning signs, a severely high number. With a financial strength rank of 5 and an Altman Z-score in distressed zones, Leucadia has a declining financial outlook. Although the company had strong Z-scores during the past 10 years, the Z-scores sharply dropped into distressed zones in 2013. The company seldom had Z-scores over 1.0 during the past three years. Additionally, the company’s profit margins have declined during the recent five-year period.
As the company is a potential value trap, several gurus trimmed their positions in Leucadia. Zeke Ashton (Trades, Portfolio) axed his stake in the company, removing 1% of his portfolio with the transaction.
Based on Leucadia’s competitive comparison analysis, Ingredion Inc. (INGR, Financial) most likely took away Leucadia’s competitive power. The starch manufacturing company has a 3.5-star predictability rank, strong financial strength scores and expanding operating margins. Additionally, the company’s profit margins and returns are near a 10-year high. With high margins, Ingredion has a profitability rank of 8.
As the company has a stronger financial outlook than Leucadia does, several gurus have increased positions in Ingredion during the past nine months. Ken Fisher (Trades, Portfolio) increased his Ingredion position quarter by quarter while Jeremy Grantham (Trades, Portfolio) purchased nearly 700,000 shares.
See also
As discussed in a previous article, you can search for potential value traps with the All-in-One Screener. While you will usually search for stocks in which to invest, you can also look for stocks to avoid or potentially short sell. Value traps make good short-sell targets based on the above discussion.
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Disclosure: I do not have any position in the stocks discussed in the article.
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