Bill Nygren: How To Avoid Value Traps

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In this interview with John Rotonti, Bill Nygren defines a value trap as a company that looks cheap (low multiples) but won’t actually become more valuable over time, typically due to structural problems. To avoid these, Nygren’s firm requires analysts to project future growth and only buy stocks with strong growth prospects. They also closely track how well a company’s value is meeting projections and are quick to sell if it falls short. Here’s an excerpt from the interview:

John Rotonti: What is your definition of a value trap? What types of stocks do you think are the most likely to end up being value traps? Do you think that companies with low or declining terminal values are susceptible to being value traps? And what actions do you take to actively try to avoid investing in potential value traps?

Bill Nygren: We define value traps as companies where value does not increase with time. The term would primarily be applied to structurally disadvantaged companies that currently trade at low multiples.

To avoid them, we require analysts to project business value seven years into the future. If the combination of expected annual value growth and dividend yield doesn’t at least match the market, we won’t buy them.

Of course, sometimes we expect value to grow as time passes, but we turn out to be wrong. We try to sell those mistakes as rapidly as we can.

We track an analyst’s estimated business value from the time the stock goes on our Approved List, and if actual growth meaningfully lags projected growth, the stock is given extra attention, including extra reviews, devil’s advocate reviews and maybe even changing the analyst who covers the stock.

The goal is to make the path of least resistance selling the stock rather than holding it.

You can read a transcript of the entire interview here:

Bill Nygren Interview – John Rotonti

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