How to avoid value traps

In my last article, I described how value investors tend to be fairly agnostic to market conditions. Instead of spending a lot of time predicting inflation, interest rates, or when the market will bottom, they focus on buying businesses when they appear cheap during periods of worry and selling them during periods of exuberance.

Many investors will have been hunting for bargains amid the market downturn. However, markets can remain in the doldrums for extended periods. Waiting for the market to recognise undervaluation may require a long wait. For this reason, many value investors also like to search for catalysts.

Catalysts

A catalyst is a specific event that may be foreseen by an investor that may cause other investors to notice that a business is undervalued. Modern markets generate so much information, from specific company results to economic data, and an investor can't hold all that in mind. Hence it is unsurprising that many companies become overlooked. This is even worse amongst the smallest companies where professional research (if it exists at all) may consist of a hopelessly biased house broker note. Identifying factors that can shine the spotlight on undervalued companies can therefore accelerate price discovery. Investors who...