Ever get caught in a value trap?

by Wayne Ferbert on October 11th, 2012

I am a value investor. I always have been. I like to pay a discount for anything. Who doesn’t like to pay a lower price?
As we all know in the markets, it takes two sides to make a market. One man’s trash is another man’s treasure. Sometimes however, you find that the treasure you bought was in fact trash.
I have gotten stuck in a few value traps in my lifetime. You just look at a stock and say: “that stock has to be worth more than that!” You look at the balance sheet and the earnings power of the company and you think that the floor is ‘already in’ and so you dive in.
But sometimes, the reason the stock is so discounted is that the competitive landscape for that firm has shifted – and the earnings power will never be the same. In fact, the company will never again compete the way it once did – and the investors realize it. As a result, not only will the earnings decrease but the multiple paid for the company collapses also.
But you convince yourself that the assets, cash, patents, etc, on the balance sheet make it completely worthwhile. This company can weather the storm and get a fair valuation again. But in reality, the company will just spend its cash and mis-manage its assets because the game has changed for them. The company is playing checkers while its competitors are playing chess.
These are the hardest value traps to avoid. Many investors got caught in the Research-in-Motion (RIMM) value trap. Everyone assumed that RIMM had too big of a base to see it get marginalized in the mobile space. But look now! It has been marginalized by Apple and Google.
Sometimes, you just need to bite off your leg to get out of the trap. You need to avoid the temptation to double down on the stock as it declines. Instead, you need to identify the sea-change and see if you need to exit. If the competitive landscape looks like it is shifting from your seat outside of the industry, chances are it is. And it is too late. You need to exit.
So, I ask you – is Hewlett Packard (HPQ) such a company? Has the competitive landscape shifted to the point where HPQ cannot emerge on the other side with a stock price north of $14? The firm meets a lot of the key requirements: strong balance sheet, several cash cow businesses, several large shrinking businesses, and a competitive landscape that is moving fast around them.
I own HPQ and so do some of our clients. I am wondering? Is HPQ worth more broken up? Is it even worth $14 per share broken up?
This is a hard one. If you have an opinion on HPQ, post it in the comments! We'll look to respond and get a dialogue going on HPQ.

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