Value Trap

DEFINITION of 'Value Trap'

A stock that appears to be cheap because the stock has been trading at low multiples of earnings, cash flow or book value for an extended time period. Stock traps attract investors who are looking for a bargain because these stocks are inexpensive. The trap springs when investors buy into the company at low prices and the stock never improves. Trading that occurs at low multiples of earnings, cash flow or book value for long periods of time might indicate that the company or the entire sector is in trouble, and that stock prices may not move higher.

BREAKING DOWN 'Value Trap'

Companies, and even sectors, can be doomed, because of situations such as the inability to survive competition, the inability to generate substantial and consistent profits, the lack of new products or earnings growth, or ineffective management. Often, a value trap appears to be such a good deal that investors become confused when the stock fails to perform. As with any investment decision, thorough research and evaluation is recommended before investing in any company that appears cheap when reviewing its relevant performance metrics.

RELATED TERMS
  1. Value Investing

    The strategy of selecting stocks that trade for less than their ...
  2. Warren Buffett

    Known as "the Oracle of Omaha", Buffett is Chairman of Berkshire ...
  3. Bottom Fishing

    Investing in stocks that are cheap because of a problem with ...
  4. Undervalued

    A financial security or other type of investment that is selling ...
  5. Fire Sale

    Selling goods or assets at heavily discounted prices. Fire sale ...
  6. Value Stock

    A stock that tends to trade at a lower price relative to it's ...
Related Articles
  1. Active Trading

    Warren Buffett: How He Does It

    We look at the Sage of Omaha's methodology for evaluating value stocks.
  2. Markets

    How To Use Price-To-Sales Ratios To Value Stocks

    Take a look at how this effective ratio can be influenced by certain critical factors.
  3. Investing Basics

    How To Make A Winning Long-Term Stock Pick

    Discover the key elements of a good long-term investment and how to find them.
  4. Active Trading

    Value Investing + Relative Strength = Higher Returns

    Buying value stocks that are moving higher helps investors steer clear of value traps.
  5. Mutual Funds & ETFs

    Value Traps: Bargain Hunters Beware!

    Find out how to avoid getting sucked in by a deceiving bargain stock.
  6. Fundamental Analysis

    Value Investing Using The Enterprise Multiple

    This simple measure can help investors determine whether a stock is a good deal.
  7. Stock Analysis

    Top 5 Stocks Listed on the Australian Securities Exchange for 2016 (RIO)

    Uncover five of the stocks listed on the Australian Stock Exchange (ASX) that offer investors the highest potential for above-average profits in 2016.
  8. Stock Analysis

    The Top Rated Dividend Paying Stocks for 2016 (ABBV, BA)

    Discover five of the top-rated stocks that pay investors solid dividends that you may want to consider adding to your investment portfolio in 2016.
  9. Stock Analysis

    Will Virtusa Corporation's Stock Keep Chugging in 2016? (VRTU)

    Read a thorough review and analysis of Virtusa Corporation's stock looking to project how well the stock is likely to perform for investors in 2016.
  10. Professionals

    Buy-Side vs Sell-Side Analysts

    Both sell-side and buy-side analysts on Wall Street spend much of their day researching companies in a relentless effort to pick the winners.
RELATED FAQS
  1. Why has the price to sales ratio become a more popular metric than it was in the ...

    The price-to-sales (P/S) ratio gained popularity during the technology boom of the 1990s when many companies with future ... Read Full Answer >>
  2. What is Fibonacci retracement, and where do the ratios that are used come from?

    Fibonacci retracement is a very popular tool among technical traders and is based on the key numbers identified by mathematician ... Read Full Answer >>
  3. What is the expense ratio in the insurance industry?

    The expense ratio in the insurance industry is a measure of profitability calculated by dividing the expenses associated ... Read Full Answer >>
  4. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>
  5. How do I use discounted cash flow (DCF) to value stock?

    Discounted cash flow (DCF) analysis can be a very helpful tool for analysts and investors in equity valuation. It provides ... Read Full Answer >>
  6. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
Hot Definitions
  1. Harry Potter Stock Index

    A collection of stocks from companies related to the "Harry Potter" series franchise. Created by StockPickr, this index seeks ...
  2. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  3. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  4. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  5. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
Trading Center