How to avoiding the Value Trap for Value Investors

The focus of value investing is basically a strategy to pick a stocks by Benjamin Graham that choose a stock that sell below their fair price. Usually, the main source of information when making the hunt is by looking at the value of PER (price to earnings ratio) and P / BV (price to book value). Common assumption that is often used is to compare the two ratios with other stocks in the same industry. At the point tersebutlah, investors sometimes face value trap. Shares are considered cheap as cheap as it was not suspected. In normal conditions, stock prices will be efficiently follow the true value. Thus, it is possible the shares which are rewarded with low PER or PBV as there are strong reasons underlying it. Then how do I avoid it? Market will become less efficient when there is a bubble or a crash.
In both conditions, market participants will be overreaktif. Stock prices are not only influenced by the fundamental condition, but also by the psychological condition of the perpetrators. Naturally, people will do anything possible when dealing with dangerous and sometimes act out of common sense. The same behavior is usually seen during the economic bubble for example when subprime mortage occur in USA. Investors tend to be optimistic and hunting stocks whose prices are expected to rise even higher. One example that has ever happened is the oil price bubble in 2007 and the dotcom boom of the 2000s.

Grand Master of value investing, Benjamin Graham himself is very aware of the threat value of this trap. Therefore he always diversify their portfolios. In one time, Benjamin Graham can have hundreds of stocks to minimize the effect of the value trap on some shares. His student, Warren Buffett said Benjamin Graham's investment strategy to improve by trying to avoid stocks that have the potential to be value traps and just focus on some stocks are considered potentially to grow.

Some examples of the value trap is (partly been explained by Investopedia):

1. PER or low PBV. As mentioned earlier, often a stock has a PER or low PBV for good reason. Possible stock priced cheap because the business can no longer thrive or even continuous losses. Always suspicious of stocks with low PER or PBV. Investigate the financial report in depth to find out that the stock is not a value trap.
2. Cyclical stocks are valued cheaply. Cyclical stocks such as automotive or retail stock will generally be soaring profits when economic conditions improve. When economic conditions worsen, these stocks will decline drastically and appreciated its performance is very cheap. Actually, no problem we buy cyclical stocks are priced very cheap as long as we are willing to be patient to wait until the economy expand and boost profits.
3. There is no catalyst. Companies that stuck its business and does not have a reliable new products will be stuck on the conditions and the market will punish him with respect to its shares on the cheap. If we buy shares in a company like this, chances are we'll be stuck in it and it is difficult to get out.
4. Looking at the performance in just a short period of time. In 1-2 years, there is a possibility the company will get a windfall in the long run it might be hard to continue. If we judge a company just based on its performance in recent periods, we will assess the business is too high and falling into the trap value.

As I point out in the previous article, make sure that we buy stocks that have strong competitive advantage to avoid the value trap. Make sure that the fundamental condition is really good before you start buying.