By MoneyMorning.com.au
One of the things I’ve been grappling with recently is the question of value versus value-traps. That is companies that look like good value versus companies that actually are good value.
For some time now the mainstream pundits have told anyone who wants to listen how cheap the market is. In fact, I remember being on CNBC about a year ago and Macquarie’s media man, who I was on with at the time, was quite dismissive of my bearish views.
According to him, the market was ‘cheap’. And that was that. End of story.
Most people have considered the market ‘cheap’ for some time. But it has ground lower since the start of the year. The problem is that most people think in terms of a ‘normal’ market environment where credit growth unleashes purchasing power into the economy, which shows up in steadily growing profits, year after year.
This is why analysts’ earnings forecasts are always higher for next year and the year after. They think we’re in a normal economy. The higher expected earnings have made the market seem cheap on a ‘forward-looking’ basis. But ever since the initial market recovery in 2009 and early 2010, these forecasts have proved way too optimistic.
And once again, it appears that forecasts for 2012 earnings might prove too optimistic too. This is why you’re seeing so many value traps – companies that look cheap but are actually ready to fall further in price.
The ‘values’ are based on excessively optimistic forward earnings. When these companies fail to match expectations, the share price falls heavily. And there’s your value trap.
In fact, I’ve identified four sectors I’m convinced will be exposed to mass selling by the end of the year. Holding shares in these sectors is putting your wealth in danger. My strategy to avoid these traps (and there have been plenty of them) is to buy good quality companies with a decent margin of safety.
Click the following link to find out how I apply this to picking stocks and the four investments you should sell NOW.
Greg Canavan
Editor, Sound Money. Sound Investments
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