Valuation
Value trap
A share that looks cheap on the numbers and stays cheap because the business is deteriorating.
How it works
The multiple is low because the market is pricing a decline that has not yet fully appeared in the accounts. Earnings then fall, and the share becomes cheaper still on a lower base.
Distinguishing a trap from a genuine bargain requires a view on why the business will stop deteriorating. Absent that, low multiples are a forecast rather than a discount.
Where it misleads people
Industries facing structural rather than cyclical decline produce the most persistent traps: things get cheaper every year and the cheapness never resolves.
Related terms
- Value investingBuying assets for less than an estimate of their intrinsic worth, with a margin of safety.
- Margin of safetyThe gap between what you pay and what you think something is worth, sized to absorb being wrong.
- Mean reversionThe tendency of extreme values — margins, multiples, returns — to drift back towards long-run averages.
- Economic moatA durable structural advantage that lets a company keep earning high returns without being competed away.
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