The cyclical nature of the stock market means that even popular stocks trade at a discount from time to time. Long-term value investors recognize that market downturns are typically only temporary, and they swoop in to buy stocks at a discount. However, sometimes a stock’s downturn is more than just a cyclical lull and can be a sign that something is critically wrong with the company’s underlying business. In these cases, a struggling stock may appear to offer a compelling value when it’s actually a value trap. Here are a few ways to recognize and avoid value trap stocks.
- Declining Revenue
Market price-to-earnings multiples expand and contract over time, and these fluctuations can account for much of a stock’s short-term price movement. However, a company with consistently declining revenue often has a major problem with its business. Sears Holding Corp (SHLD) shares are down 77 percent in the past five years, but the company’s revenue has also steadily declined by 48 percent in that time. Companies with declining revenue can stay profitable for years by cutting costs and relying on business from their remaining loyal customers. Unfortunately, when revenue is disappearing, long-term value is…
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