Falling into value traps is one of the biggest mistakes value investors make. Value traps tend to appear cheap, but their business internals are deteriorating – the business is destroying value.GuruFocus discusses how to avoid value traps in the following article. The article pointed out that one sign of a value trap is declining profit margins, as seen clearly from companies like Research-In-Motion (RIMM), Nokia (NOK) and RadioShack (RSH).GuruFocus' Warning Signs feature warns you if a stock's profit margins have declined over the past five years. Using our All-in-one Screener, we did a simple screen for companies that are having declining profit margins in the technology and consumer service sector. The market cap of the companies is at least $1 billion. These companies have seen declining profit margins during the five-year period ending 2012:
Some of the margin declines are caused by the structural change of the business. The company may go through acquisition or spin-offs. Some of them do have long-term decline.A few examples include Cardinal Health Inc. (CAH) and Carnival Corp. (CCL).
Renowned short-seller
Jim Chanos (Trades, Portfolio) shorted HP Inc. (HPQ) during 2012, saying it is a value trap. It does have the sign of it: long-term margin decline:
Will we know if HP CEO Meg Whitman can turn things around? We don’t know, and that is again a “too-hard” question to answer. There are plenty of companies that are of higher quality and have sustainable profit margins. Why would we want to bet on it? Berkshire Hathaway Inc. (BRK.A)(BRK.B) CEO
Warren Buffett (Trades, Portfolio) said many times that he prefers to buy "good companies at fair prices." The Buffett-Munger model portfolio has returned a cumulative 318.05% from its inception in January 2009 to August 2022.
GF Value Line also warns of possible value trapsGuruFocus' GF Value Line also warns you if a stock is a possible value trap. For example, consider Jack In The Box Inc. (JACK).
According to the GF Value Chart, GuruFocus' GF Value Line labeled Jack In The Box a possible value trap based on its price-to-GF-Value ratio of 0.58 and several warning signs, including low financial strength and declining gross profit margins during the five years ending March 2022.
| Symbol | Company | Share Price ($) | Market Cap (mil) |
| CVS | CVS Caremark Corporation | 45.94 | 61576.2 |
| CAH | Cardinal Health, Inc. | 43.185 | 14715.1 |
| OMC | Omnicom Group Inc. | 50.09 | 13237.2 |
| MAR | Marriott International, Inc. | 36.77 | 12008.9 |
| HOT | Starwood Hotels & Resorts Worldwide, Inc | 51.11 | 10004.9 |
| LUV | Southwest Airlines Co. | 9.42 | 7251.1 |
| CSC | Computer Sciences Corporation | 23.85 | 3686.1 |
| NCR | NCR Corporation | 24.51 | 3630.6 |
| WEN | The Wendy's Company | 4.77 | 1863.7 |
| MTN | Vail Resorts, Inc. | 49.8 | 1775.8 |
| CAKE | The Cheesecake Factory Incorporated | 32.4 | 1721.6 |
| CAR | Avis Budget Group Inc. | 15.32 | 1618.7 |
| BGC | General Cable Corporation | 27.7 | 1336.2 |
| TXRH | Texas Roadhouse Inc | 18.47 | 1276 |
| JACK | Jack in the Box Inc. | 27.55 | 1251.8 |
Some of the margin declines are caused by the structural change of the business. The company may go through acquisition or spin-offs. Some of them do have long-term decline.A few examples include Cardinal Health Inc. (CAH) and Carnival Corp. (CCL).
Renowned short-seller
Jim Chanos (Trades, Portfolio) shorted HP Inc. (HPQ) during 2012, saying it is a value trap. It does have the sign of it: long-term margin decline:Will we know if HP CEO Meg Whitman can turn things around? We don’t know, and that is again a “too-hard” question to answer. There are plenty of companies that are of higher quality and have sustainable profit margins. Why would we want to bet on it? Berkshire Hathaway Inc. (BRK.A)(BRK.B) CEO
Warren Buffett (Trades, Portfolio) said many times that he prefers to buy "good companies at fair prices." The Buffett-Munger model portfolio has returned a cumulative 318.05% from its inception in January 2009 to August 2022.GF Value Line also warns of possible value trapsGuruFocus' GF Value Line also warns you if a stock is a possible value trap. For example, consider Jack In The Box Inc. (JACK).According to the GF Value Chart, GuruFocus' GF Value Line labeled Jack In The Box a possible value trap based on its price-to-GF-Value ratio of 0.58 and several warning signs, including low financial strength and declining gross profit margins during the five years ending March 2022.
