Value And Value Traps

By Sham Gad | February 13, 2012 AAA

If one is willing to look far and wide, potentially valuable opportunities can appear where it's least expected. By its nature, the investing media can only cover a fraction of the companies that are owned by the public. Businesses that are too small, thinly traded or choose not to publicize themselves are left alone only for the diligent investor to uncover. (For related reading, see The Value Investor's Handbook.)

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Hidden Gems
Motorcar Parts of America (Nasdaq:MPAA) could turn out to be a hidden gem. The company is in the midst of its largest acquisition which caused the company to delay its quarterly filing. Caught off guard, investors dumped shares leaving them at around $7 or roughly 75% of book value and trading at over six times forward earnings. Motorcar Parts is a leading supplier of alternators and starters to auto parts retailers and repair shops in North America. The auto parts industry is booming and MPAA should benefit from those tailwinds. A year ago shares in MPAA were trading for about $15. Once investors get comfortable with the acquisition, shares could move up as quickly as they pulled back. Just look at Standard Motor Products (NYSE:SMP), another provider of automotive replacement parts. Since September, shares have climbed by over 100% as investors caught on the growth story of the auto parts business. (To learn more, read Analyzing An Acquisition Announcement.)

Look out for Traps
Semiconductor company FormFactor (Nasdaq:FORM) looks more dead than alive. The company has a market cap of around $268 million against shareholder equity of approximately $411 million. Most of that book value is in cash and short-term investments. Trading at about $5.35 a share, FORM is debt free with $6.26 in cash per share and a book value per share of $7.48. What's the catch? The company is losing money. Losses are weakening the balance sheet. A great balance sheet is only as good as it lasts and if a business is burning cash, a superb balance sheet may be a trap unless the company decides to liquidate its assets. Despite the appealing balance sheet, investing in a balance sheet that is being weakened by a money-losing business is just as dangerous as investing in an overvalued businesses like lululemon athletica (Nasdaq:LULU) on promises of high growth. Both approaches can leave an investor poorer.

The Bottom Line
Finding value in stocks comes in a variety of ways. The fine line is deciphering between value opportunity and value trap. For investors, it's always best to first tackle ideas with a healthy dose of skepticism. (For additional reading, see Value Investing + Relative Strength = Higher Returns.)

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At the time of writing, Sham Gad did not own shares in any of the companies mentioned in this article.

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