11 Major Risks for Value Investors With Stocks at All-Time Highs

Investing

Published: July 12, 2019 7:25 am

Last Updated: January 11, 2020 7:48 am

The bull market is now well into its 10th year, and many investors have been scratching their heads, trying to figure out how to be positioned heading into 2020. On top of an upcoming election and the media constantly warning that the next recession could be imminent, the Dow Jones industrial average, S&P 500 and the Nasdaq Composite have all challenged all-time highs in July.

Is this a time for investors to consider rolling out of growth and into value? Some investors might choose the safety of lower valuations and dividends over some of the high-growth stocks. However, value investors had better be very cautious about what sort of “value” they are looking for.

One steadfast rule of investing is not to fight the tape. In short, if the market or a sector keeps ticking up, it might not be best to look at the stocks that are down and out. If a stock is hitting 52-week lows when the market is hitting all-time highs, imagine how crummy it might be in a bad market. Still, some investors want to feel like they are getting to buy a stock or a sector when they are at bargain prices and valuations.

Value investors have to understand that there are many reasons why stocks look cheap at any given time. If the market is valued at 18 times expected earnings, then stocks valued at eight times and 10 times expected earnings have to sound dirt cheap. There is usually a reason for that. This is where value investors can get caught easily in a so-called value trap.

24/7 Wall St. and its founders have evaluated stocks, bonds and other asset classes for many years now. One issue that remains puzzling is how and why many investors improperly evaluate companies and sectors during a bull market. Value investors want a bargain, but they often ignore or overlook the signs that a value trap is just about to eat into their assets.

It is important to consider numerous issues and risks in value investing. Stocks that appear to be cheap are usually cheap for a reason. It’s also important in value investing that when those “buy levels” become too tempting an investor should never try to jump in all at once. “Cheap stocks” aren’t just cheap for a reason, but they usually stay cheap for more than just a few days or weeks.

There is almost always more to an investing thesis than a simple price-to-earnings (P/E) ratio. There is also more than just looking at past balance sheets and assets to determine what a fair value happens to be. Dividend cuts, accounting errors, tax issues, shareholder suits, product liabilities and management fraud call all take a good value story and balance sheet down the drain.

24/7 Wall St. has identified 11 specific areas that investors need to consider when it comes to value investing now that the stock market has again challenged new all-time highs. With the Dow at 27,000 and the S&P 500 having crossed the 3,000 level for the first time, it makes sense to be cautious in stocks and sectors that are down 20% or 30% from their highs.

Companies tend to have unique stories, regardless of what is happening in the market or the economy. Just look at the world of conglomerates at this stage of the bull market and try to pinpoint just one or two key issues in each to figure out why they look “cheap” in an expensive market. Ditto for steel and metals stocks, and why are so many transportation and financial stocks screening out as “cheap” and not participating as much as the broad market rally would suggest? It is also easy to find brick-and-mortar retailers valued at less than 10 times earnings in 2019, but that is because the investing community is worried about existential risks from the online and multichannel threats from the likes of Amazon and a few other behemoths.

Investors must pay attention to the obvious signs about when value stocks really are value traps at a time when the stock market is hitting all-time highs. If investors are not careful, they could face substantial losses or they could lose their entire investments. Moreover, falling into a value trap often comes with a cardinal sin of accidentally owning a company that they just did not really understand.