Markets will exploit investors who are too patient and forgiving on companies that are the value traps.
These companies mask as deeply discounted companies that appear to have plenty of margin of safety and low risk. Those stocks are cheap for a reason. Their business model lacks a meaningful catalyst that will turn its fortunes around. Until that happens, the company’s revenue and corresponding earnings are at risk of getting worse.
Investors become bagholders when they buy companies that are struggling. Higher operating costs, out-of-date products, and past missteps are only a few of the reasons a company fell behind. It could take many years before the business fixes its issues. As a result, the stock price is unlikely to increase in value.
Astute readers may avoid the punishment of such holdings with the seven value traps discussed below.
|CS||Credit Suisse Group||$2.88|
Chegg (NYSE:CHGG) shares fell to the teens when it posted fourth-quarter results on Feb. 6, 2023. Markets did not like the education technology firm’s year-on-year revenue decline, which fell by 1.1%.
The first quarter of 2023 does not look good. Net revenue of $184 million to $186 million is below the Q4/2022 revenue of $205.2 million.
Chegg posted a meaningful profit, positive free cash flow, and minimal capital expenditures, but is still one of the value traps to avoid. It expects new subscribership growth in the U.S. as students return. However, Chegg needed to lower prices in several countries to attract them.
The company invested in a Turkish and Mexican app. This increased both renewals and conversion to paid subscribers. These ongoing investments need to continue. Chegg is spending on increasing its content. Hopeful shareholders expect an expansion in the addressable market.
Chegg’s investments have yet to pay off. It is in the beginning phases of raising its expenditures. Costs could increase faster than revenue growth. This will cause CHGG stock to sell off again,making it one of the value traps to avoid.
Credit Suisse Group (CS)
Credit Suisse Group (NYSE:CS) is a global investment bank based in Switzerland. Its balance sheet is so dire that it needed investments from Qatar Investment Authority.
Qatar’s sovereign wealth fund bought a 6.8% stake in Credit Suisse. Saudi National Bank has a bigger holding with a 9.9% stake.
In February, the firm had discussions with Apollo Global Management (NYSE:APO) about selling its investment bank, CS First Boston. This would raise $750 million for Credit Suisse, which it needs to de-leverage its balance sheet.
CS said that it reshaped its CS First Boston to be capital-light, balance sheet efficient, and with the right staff levels. Its overall business needs to align with the negative macroeconomic realities.
The firm needs to cut staff count and costs as business conditions worsen. Its wealth management and Swiss Bank franchises are not prepared for a slowdown.
CS stock has too many turnaround risks. After it raises capital and sheds assets, it has limited options available to reignite the core business.
Ford Motor (F)
Ford Motor (NYSE:F) rewarded its loyal investors and the Ford family with a special dividend of 65 cents a share.
This is a distribution from its profitable gains from the sale of Rivian (NASDAQ:RIVN) shares. The onetime dividend income boost is not a good enough reason to stay invested.
Last month, Ford halted production of its F-150 Lightning. It will restart production on March 13, after figuring out the problem with the battery. In a hyper-competitive EV market, Ford cannot afford such negative news.
Customers are wary of buying more expensive EVs. The 2023 recession will discourage consumers from buying EV trucks at a price range higher than gas-powered vehicles.
The company announced plans to build an EV battery plant in Michigan for $3.5 billion. This will use Chinese technology. The U.S. government might scrutinize Ford’s deal with Contemporary Amperex Technology Co. Ltd. since tensions between the U.S. and China are high.
Still, Ford’s vice president of EV industrialization, Lisa Drake, did not express any concerns.
General Motors (GM)
General Motors (NYSE:GM) announced a $650 million investment deal in Lithium Americas (NYSE:LAC).
It invested in the construction of Thacker Pass to secure the U.S. supply chain for EV raw materials. GM’s aggressive investment shifts mining costs to investors.
The mining investment is part of GM’s plan to build its portfolio of battery raw materials. It fully secured all its battery raw materials through 2025. This will decrease the risk of spot price movements as it signs fixed-price contracts. This approach increases GM’s risk of losses if prices for raw materials fall.
Investors who are bullish on the EV market will not expect prices for lithium to fall. Still, the near-term demand for EVs may slow down if the economy weakens. At current demand levels, the EBIT margin in the low single-digit percentage is not attractive.
GM is cutting operating costs by $2 billion as it realizes operational synergies. If it cut too aggressively to drive efficiencies, customers may suffer from worsening service quality. Without profit growth, investors are stuck holding a value-trap stock.
L3Harris Technologies (LHX)
L3Harris Technologies (NYSE:LHX) is trading in a downtrend in the last year. Despite raising its dividend by two cents to $1.14 a share, this is one of the seven value traps to avoid.
On Dec. 18, 2022, L3Harris announced it would acquire Aerojet Rocketdyne (NYSE:AJRD) for $4.7 billion. The purchase adds integration work effort for the company. Shareholders face more risks from here. L3 may not realize as much revenue synergy as first thought.
While management works through the deal, risks of escalating war may subside. That would cause the demand for military-related goods falling. L3Harris needs to sell assets in the next few years to bring down its debt. The value of its assets could fall if it does not find a willing buyer.
In Q4, L3Harris posted strong results. Revenue grew by 5.24%. The company bought back $1.9 billion worth of shares and paid nearly $400 million in dividends in 2022. Those steps increased shareholder returns but did not stop the stock from falling.
Medtronic (NYSE:MDT) posted revenue growing by only 0.5% Y/Y to $7.7 billion. It raised its revenue and earnings per share outlook for the next quarter and year.
Markets did not react positively to the stronger guidance. The stock fell from $85 to below $82 before rebounding. Investors are concerned that the operating expense cuts will hurt its longer-term prospects. Chief Financial Officer Karen Parkhill said that it is offsetting headwinds by reducing its costs.
On its profit-and-loss line, Medtronic’s gross margin could worsen as the impact of inflation shows up. CFO Parkhill said that it needs significant expense reduction to prepare for a tougher year on its bottom line.
China is a growth opportunity for procurements. However, Medtronic had discussions with Chinese government officials. It expects the fiscal year 2024 will be another headwind. Shareholders will need to wait another year before markets assign higher valuations on this beat-up value trap.
Teladoc Health (TDOC)
Teladoc Health (NYSE:TDOC) is the biggest of the seven value traps. It posted weak revenue growth and a loss in the fourth quarter. Its guidance for the first quarter and the full year are just as disappointing.
In Q4, Teladoc reported revenue growing by 15.1% Y/Y to $637.7 million. It lost 23 cents a share (non-GAAP). The weak results are deeply concerning. Management cannot accelerate the virtual health business model. Its problems stem from uncertainties in the BetterHelp segment.
Teladoc’s CFO, Mala Murthy, said that BetterHelp operates in an under-penetrated virtual therapy market. It believes it has tailwinds. However, the FO conceded it chooses to grow at a slower rate and achieve margin improvements of 100 to 300 basis points.
Without contract wins from large corporations, Teladoc cannot offer more value-based arrangements to grow its customer base. For now, the headcount reduction of 6%, or 300 staff, might right-size its costs. This will put pressure on Teladoc to achieve higher efficiencies to slow its quarterly losses.
Chances are low that the company has blockbuster products like Primary360 that will expand its service demand.
Avoid the uncertainties by avoiding TDOC stock.
On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
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