The 9 types of value traps to avoid

The 9 types of value traps to avoid in value investingAs we have already seen, value traps they are one of our greatest enemies as inversores “value”. Therefore, it is vitally important to know how to detect them in time to avoid falling into them. To help you with this difficult task, I have made a short list of 9 types of value traps that we must avoid in our investment portfolios.

Fad companies

A good example of value traps are usually companies that, for whatever reason, have become fashionable. The problem is that on many occasions this fashion is ephemeral, although many are not able to realize it in time.

Crocs Inc

Crocs Inc

A good example of this type of company is Money, Bank Credit and Business Cycles”By Jesús Huerta de Soto. This work was the one that helped me to understand in depth the cyclical nature of the economic and financial system that prevails today and the danger that this poses for investors.

The change in the economic cycle was the cause of the appearance of value traps in the Spanish real estate sector, in which many investors ended up falling and losing a good part of their savings.

Analysis performed with the wrong valuation methods

I already spoke to you a long time ago on the blog of the different valuation methods and which are the most suitable for each occasion. The confusion when it comes to choosing the most appropriate method to value a company can cause us to be victims of value traps.

A good example of this type of value trapping happened during the dot-com bubble. During this period, many professional analysts used new valuation methods that made it appear that internet stocks were trading relatively cheaply despite one of the largest bubbles in stock history.

Companies affected by disruptive innovations

We already saw in this blog what are the disruptive innovations and its effects on many companies, so I encourage you to read the article in which I talk about them. The best example of this type of company is the so-called Encarta companies, of which I also spoke to you recently here.

Public enterprises

Public companies are another major source of value traps. While the objective of private companies is usually, in principle, to maximize the value for their investors, in the case of public companies this is not always the case.

Petrobras quotation

Petrobras quotation

An example of a value trap in a public company can be that of the Brazilian oil company Warren Buffett:

"Only when the tide goes out you know who swims naked"

Excessively indebted companies

These value traps are usually related to those of the previous type. This was the case of Telefónica, a company that, without being exceptional, could have had a much higher stock market performance if it were not for the excess of debt that made it had to divest in profitable divisions and considerably reduce its remuneration for dividends to its shareholders in recent years.

End of competitive advantages

The competitive advantages they are never eternal. They can last more or less time, but sooner or later they end up disappearing. Some have a specific time, as is the case with patents, while in most cases their duration is indeterminate.

Many times we do not take into account that competitive advantages can deteriorate and that this deterioration can have as a consequence a drastic reduction in the value of these companies.

Fraudulent accounting

This is undoubtedly the most difficult type of value trapping to detect, as the management of companies with fraudulent accounting go to great lengths to mask it. Even investors of the stature of the Bestinver They fell into the value trap set by the company Beneish M-Score, of which I have already spoken recently.

More examples of types of value traps

These are just a few examples of types of value traps, but surely you can think of more.

If so, I encourage you to share it or leave any criticism in the comments. 😉