The Dangers of Investing in Value Traps

Jeff Yastine

Editor, Total Wealth Insider

Contributor's Links: Banyan Hill Publishing

Jeff “JL” Yastine is the editor of Total Wealth Insider. He first joined Banyan Hill Publishing as editorial director in 2015, bringing with him more than two decades of experience as a stock market investor and financial journalist at the center of financial world events. Jeff is also a weekly contributor to Banyan Hill’s Sovereign Investor Daily and Winning Investor Daily, helping investors understand business, economic and monetary trends, and highlighting the profit-making opportunities brought to light by our financial editors. An Emmy-nominated anchor and correspondent at PBS Nightly Business Report from 1994 to 2010, Jeff has interviewed and learned the investing secrets of some of the most successful financiers and entrepreneurs of the era, such as Warren Buffett, Michael Dell, Sir Richard Branson and many others. Jeff’s reporting also helped identify successful investment opportunities in small-cap growth stocks and large company turnarounds, as well as across a wide variety of sectors, from “big box” retail to agriculture and developments in the biopharmaceutical sector. Jeff’s reporting helped warn investors about the real estate crisis of the mid-2000s and the unsustainable rise of the 2000 dot-com bubble. He also reported on major national events such as the Deepwater Horizon oil spill in 2010, the financial impacts of Hurricane Katrina in 2005, the influence of foreign automakers as they built new manufacturing plants in the southeastern United States and the historic handover of the Panama Canal in 1999. Jeff also visited Cuba twice, in 1994 and 2003, to report on the role of foreign investors on that nation’s economy. Jeff was nominated for a 2007 Business Emmy Award for his reporting on America’s underfunded system of roads, bridges and other forms of public infrastructure. He was also part of a 2002 team of NBR journalists who won the New York State Society of Certified Public Accountants’ Excellence in Financial Journalism Award for a half-hour special report on the nation’s bond market.less

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The Dangers of Investing in Value Traps

Date: Wednesday, October 18, 2017 12:25 PM EDT

When it comes to investing, there are two kinds of stocks: those with value, and those that are “value traps.”

What’s the difference?

The epic debacle of one hedge fund offers clues. Bruce Berkowitz, founder of the Fairholme Fund, once controlled $20 billion worth of assets at the fund’s peak in 2011. The fund is now worth less than $2 billion.

His bet on Sears Holdings Corp. (Nasdaq: SHLD) provides a warning on how looking for value in an individual stock can lead an investor over the edge.

Sears Has Had Its Day

As recently as June, Berkowitz told investors Sears was worth $90 per share based on its real estate and valuable brands, according to Reuters. The company’s operating losses, he said, were impeding the realization of that value in the company’s stock price.

I don’t know about you, but Sears doesn’t look to me like it’s going to $90 anytime soon — or ever:

The problem for Berkowitz, and any investor, is looking beyond a company’s financial statement, and recognizing when the company’s “had its day” — and no amount of new capital is going to turn it around.

You can sell and spin off assets — Sears Chairman Eddie Lampert (a hedge fund veteran himself) authorized the sale of Sears’ Craftsman brand for $900 million. He also created Seritage Growth Properties (NYSE: SRG) as a holding company for the real estate underneath Sears stores around the U.S. Warren Buffett is reportedly an investor in those shares.

But Sears the retailer? Its final chapter was already being written in the 1980s, when Wal-Mart began expanding aggressively across the South and went national in the 1990s.

Some investors learn this early in their careers. Buffett famously invested in a struggling New England textile company in the 1960s, adding new capital by buying advanced looming machines for the operation. But at the end of the day, he realized no amount of extra investment was ever going to turn the company around.

The name of the struggling textile mill? Berkshire Hathaway. Buffett kept the name, but eventually sold off everything else.

For other value investors, like Berkowitz, they’re forced to learn the same lesson later in their careers.

Kind regards,

Jeff L. Yastine
Editor, Total Wealth Insider

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