Watch Out for These ‘Value Traps’

Bank of America’s quant strategists have identified stocks and industries that may trip up value managers.

Ty Wright/Bloomberg

Ty Wright/Bloomberg

Some stocks look good for the wrong reasons.

Quantitative strategists at Bank of America Corp. have identified industries they view as “value traps,” including real estate investment trusts, telecommunications, and multi-utilities, according to their research note Tuesday. Value-trap industries have lagged their benchmark by 17 percentage points this year and have underperformed by 4 percentage points annually since 1997, the strategists warned.

Such stock traps have attractive valuations as well as falling price momentum and earnings revisions relative to the Standard & Poor’s 500 stock index. Investors should beware when their prices are declining faster than earnings are deteriorating, according to the strategists, whose tactical analysis is meant for investors with a one-to-three-month time horizon.

“Not all value is created equal,” they said. “Value managers lose by buying too early too many times.”

True value resides in traditional cyclical industries like household durables, autos, metals and mining, construction materials, and semiconductors, according to their note. Such “good value opportunities” are backed by improving fundamentals as well as price momentum, they said.

Value-trap industries, on the other hand, may look inexpensive but have failed to outperform the market in the subsequent twelve months 62 percent of the time since 1997, their research found. These industries “generally need an external catalyst to propel them out of their valuation quagmire,” the strategists said.

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Equity REITs are one area of markets where investors should tread carefully as the industry faces structural headwinds from the Covid-19 pandemic, according to Bank of America. For example, the research note showed Welltower — a REIT that invests in senior housing and health-care infrastructure including post-acute care centers — was screened as a value trap.

Other individual stocks flagged as value traps include telecom company CenturyLink, insurer Prudential Financial, and information technology business Automatic Data Processing, the Bank of America note showed. More broadly, the bank’s quant strategists pointed to health-care technology, industrial conglomerates, and diversified consumer services as industries appearing cheap for the “wrong reasons,” meaning their relative prices are tumbling faster than earnings are sliding.

With the stock market trading at expensive levels, the Bank of America strategists said they prefer “value” to “growth” for macro and micro reasons. “But watch out for traps.”