Knowing what the stock market will bring in 2025 is nearly impossible. But there are some things that investors like me can do to give themselves the best chance of doing well, whatever happens.
One of these is staying out of value traps – stocks that look cheap but are actually not. And avoiding these is my investment resolution.
Value traps
There’s more than one type of value trap. The most obvious kind – and the easiest to avoid – are ones where a stock looks cheap because the underlying business has a permanent problem.
With one or two minor exceptions, I’ve done a decent job of staying out of these kinds of stocks in the past. But unfortunately, there’s a more complicated type of value trap that’s harder to avoid.
Fundamentally, investing is about buying shares for less than they’re worth. But this isn’t the only thing that matters – a stock that’s trading below its intrinsic value can still turn out to be a bad investment.
If a stock’s trading 20% below what it’s worth, I expect the value to be unlocked sooner or later. But if it takes five years for this to happen, I might well do better buying an index that tracks the FTSE 100.
Finding shares that are trading below their intrinsic value therefore isn’t enough to make a good investment. Investors also need a reason for thinking the returns are going to come soon enough.
This is something I’ve not always paid close enough attention to in the past. And my resolution for 2025 is to try and make sure I avoid these kinds of value traps.
How I plan to avoid them
My plan for avoiding these long-term value traps involves trying to identify what is going to unlock the hidden value in a stock before buying it. And this is something I’ve started to make progress with.
FTSE 100 conglomerate DCC’s (LSE:DCC) a good example. The company has energy, healthcare, and technology divisions and I think the stock’s undervalued at the moment.
In terms of operating profits, the company managed 3.4% growth last year, which is modest. But the reason for this is the healthcare and technology units both reported declines.
DCC’s energy business actually generated £503m in operating income and grew 10% in 2024. And with the entire company having a market-cap of £5bn, this makes the stock look like a bargain.
By itself, the fact the stock looks undervalued isn’t a good enough reason for me to buy. But management’s planning to sell off its underperforming divisions to unlock this value.
With its balance sheet in good order, the intention is to return the proceeds from the sale to investors as a dividend. And this would leave them with the energy business, which looks to have a bright future.
Risks
There is, of course, a significant risk with this strategy. Over the long term, divesting the other units removes some of the benefits of diversification for DCC shareholders.
That’s something I’m mindful of going forward with the stock. But my hope is that I have at least avoided the risk of owning an undervalued stock that ultimately takes too long to recover.
This post was originally published on Motley Fool
