Long-term success in investing comes as much from finding great ideas as from avoiding the duds. The secret formula for successful investing is well-known: find a great business and make sure you don’t overpay for that. Over the long term, your returns will match the returns of the underlying business.
However, what happens when a company in your portfolio suddenly reports slowing growth and weakening margins. Is this the time to review your assumptions about its long-term potential or shrug it off and wait for the next results? You may decide that rising uncertainty demands a lower valuation multiple, but the stock is quick to react to weak numbers and drops by 20%, reducing the multiple. Often subsequent results are disappointing again, and the stock falls further.
Is this the time to quit and call the stock a value trap, or maybe what is needed in this situation is more patience? There are no simple answers, and a lot depends on specific details in each case.
I will briefly review the case of Meta (Facebook) in the second half of this article. But before I do it, I would like to review some common factors that can make a seemingly attractive business a value trap.