How to avoid the value trap

Sensible investors know that, in the long run, value stocks deliver superior returns to growth stocks. Furthermore, as disciples of Benjamin Graham will tell you, companies that are acquired at lower valuation multiples have a built-in margin of safety. If this is the case, how can we explain why value investors have tripped up so often in recent years — losing money on cheap U.S. housing stocks and banks prior to the financial crisis, and more recently on mining and energy stocks bought at apparently low valuations? There’s a simple answer. All these value traps experienced high levels of asset growth prior to their collapse. Investors that looked only at traditional valuation measures, such as price-to-book or price-to-earnings, and ignored changes in industry supply conditions have been blindsided. Businesses in sectors that have experienced rising levels of capex and supply — such as mining and energy — should be avoided even when they look cheap, according to Marathon Asset Management. (VIEW LINK)