Should value investors be wary of these industries?

Quantitative strategists flag stock 'value traps' that have lagged their benchmark so far this year

Should value investors be wary of these industries?

One thing you can rely on many value investors to do after a historic downturn like the first quarter’s COVID-19-driven selloff is look for bargains among beaten-down stocks and sectors. But one group of strategists warns that some apparently good buys may deserve a second look.

“Not all value is created equal,” said the group of quantitative strategists at Bank of America in a new note. “Value managers lose by buying too early too many times.”

As reported by Institutional Investor, the strategists said “good value opportunities” have improving fundamentals as well as price momentum on their side. Some sectors that hold true value, they said, include traditional cyclical industries such as household durables, autos, metals and mining, construction materials, and semiconductors.

On the other hand, some stocks and sectors with attractive valuations can turn out to be “value traps” if they display hallmarks such as falling price momentum and earnings revisions compared to the S&P 500. With a tactical analysis geared toward investors with a one- to three-month time horizon, the strategists advised caution on stocks whose prices are declining faster than their earnings are deteriorating.

Based on those criteria, they identified real estate investment trusts, telecommunications, and multi-utilities as value-trap industries. Such industries, they said, have lagged their respective benchmarks by 17 percentage points so far in 2020, and have underperformed by 4 percentage points on an annualized basis since 1997.

Further, the research found that value-trap industries may look inexpensive, but have wound up failing to outperform the market in the subsequent 12 months in 62% of cases since 1997. As the strategists explained, such industries “generally need an external catalyst to propel them out of their valuation quagmire.”

At present, the analysts said equity REITs represent an area where investors should take caution, particularly amid structural headwinds generated by the COVID-19 pandemic. They flagged Welltower, a REIT that invests in senior housing and healthcare infrastructure, including post-acute care centres, as a value trap for investors.

Healthcare technology, industrial conglomerates, and diversified consumer services could also be identified as value opportunities for the “wrong reasons,” the analysts added, noting that their relative prices are spiralling faster than their earnings are sinking.

And while the prefer “value” to “growth” for macro and micro reasons – including the expensive levels at which the U.S. stock market is trading – the strategists encouraged investors to “watch out for traps.”


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