Characteristics of Value Stocks and Value Traps

January 12, 2014 Leave a comment

Characteristics of Value Stocks and Value Traps

by Jae JunJanuary 10, 2014

Can we Boil Down Value Traps Into a Number of Characteristics? Vitaliy Katsenelson, author of Active Value Investing, and creator of the Katsenelson Absolute PE valuation model, hosts a conference called VALUEx. In June, Jim Chanos, legendary short seller, gave a presentation on the topic of value stocks and value traps which I wanted to highlight.

Value Stocks: Definitive Traits

Predictable, consistent cash flow

Defensive and/or defensible business

Not dependent on superior management

Low/reasonable valuation

Margin of safety using many metrics

Reliable, transparent financial statementsDo these 6 points remind you of somebody who said similar things?

For me, Buffett came first to mind.

Buffett has preached about cash generating companies, companies with a wide moat, a business where any dummy can run it, cheap or fair price for a great company, seek margin of safety and clean accounting.

These six points succinctly define great companies at cheap to fair prices.

Companies like International Business Machines Corp. (NYSE:IBM), Waste Management, Inc. (NYSE:WM), Wal-Mart Stores, Inc. (NYSE:WMT), Microsoft Corporation (NASDAQ:MSFT) fit the description.

 

Value Traps: Some Common Characteristics

Cyclical and/or overly dependent on one product

Hindsight drives expectations

Marquis management and/or famous investor(s)

Appears cheap using management’s metric

Accounting issues

Note that these are just some common characteristics and not everything can be boiled down to five characteristics.

But if you read some books and case studies on short selling such as The Art of Short Selling, you will realize that some of the five themes do come up often.

Of particular interest to me is the third point about famous investors which is not something I had considered.

It reminds me this particular bias and how easily we can get fooled by following smart money too.

Skill bias
When education and training causes confidence to increase faster than ability.

The best example is the hedge fund Long Term Capital Management. Staffed thick with PhDs and two Nobel laureates, the fund exploded in 1998 under an incomprehensible amount of leverage. Behind the failure was raging overconfidence. “The young geniuses from academe felt they could do no wrong,” Roger Lowenstein wrote in the book When Genius Failed.

Warren Buffett said this about the firm’s sixteen-person management team:

They probably have as high an average IQ as any sixteen people working together in one business in the country … just an incredible amount of intellect in that group. Now you combine that with the fact that those sixteen had extensive experience in the field they were operating in … in aggregate, the sixteen probably had 350 or 400 years of experience doing exactly what they were doing. And then you throw in the third factor: that most of them had virtually all of their very substantial net worths in the business …And essentially they went broke. That to me is absolutely fascinating.

Coinstar (CSTR) Being Shorted by Chanos

The reason why I’m writing this post in the first place, is because I was looking at Coinstar (CSTR) and Chanos’s short position was what caught my eye.

As I was briefly glancing through the numbers, Coinstar is at very attractive valuation levels.

Check out some of the numbers below taken from the stock valuation and analysis spreadsheets.

 

Numbers look great, but I’m not convinced about the business model.

Majority of the revenue comes from Redbox kiosks, but how long will DVD distribution last in a world where everything is going digital and devices make it easier to consume digital content?

I won’t get into a full stock analysis, but the short seller’s analytical method of trying to find how and why an investment will break sure is interesting and brings a completely different perspective to your analysis. Could this be one of the value traps?

I’ll let you enjoy the details of Chanos’ shorting positions and reasons from his presentation.

Filed under Investing Process

Unknown's avatarAbout bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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