Unmasking The Value Trap

A value trap is a situation in which an investment appears to be undervalued based on traditional valuation metrics. They may be trading at low price to earnings ratio or price to book ratio or higher dividend yield but the stock price continues to decline or remains stagnant for an extended period. The article takes a closer look at how value trap works and how it can be avoided

In the bustling city of Mumbai lived a young and ambitious investor named Ravi Raskar. Ravi had always been fascinated by the world of finance and had a keen interest in exploring various investment strategies. He had heard tales of great investors who had amassed tremendous wealth by following the principles of value investing. He was especially inspired by Warren Buffett, referred to as the ‘Oracle of Omaha’, whose investment approach is heavily influenced by value investing principles. Buffett’s story of buying See's Candies is often cited as an example of his value investing principles. He purchased the company in 1972.

Although See’s Candies was a relatively small acquisition, it became a highly profitable investment for Berkshire Hathaway over the years. Intrigued by the idea of identifying undervalued stocks with great potential, Ravi set out on his own investment journey. He analysed the current market and saw that value theme was greatly outperforming the Nifty 50. Since the start of 2020, Nifty Value 50 has moved up by 105 per cent till now. In the same period, Nifty 50 has gained 54 per cent. Armed with a strong belief in the power of value investing, Ravi plunged headfirst into the stock market. He meticulously researched companies, studying their financial statements and analysing their past performance.