Glossary

Value trap

A stock that looks cheap but stays cheap, or gets cheaper, because the business is declining.

A value trap is a stock with a low price-to-earnings or price-to-book ratio that tempts bargain hunters, but whose low price reflects real problems: shrinking sales, falling margins, heavy debt or an industry in decline.

The cheapness is a symptom, not an opportunity. Earnings fall, so the stock that looked cheap on last year's profits turns out to be expensive on next year's.

To tell a bargain from a trap, look past the valuation to the business: is it growing, profitable and producing cash?

  • Stock screener: A tool that filters thousands of stocks down to the few that meet your rules.
  • Fundamental analysis: Judging a company by its business (sales, profits, cash, debt) rather than by its share-price chart.
  • Accruals: The part of reported profit that has not arrived as cash yet.

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