Beware of 'Value Traps' Ford, HP, SanDisk

BOSTON (The Street Ratings) -- Ford (F), Hewlett-Packard (HPQ) and Marathon Oil (MRO) are stocks that have fallen enough that they've become attractive to some investors.

But be careful -- they may be so-called value traps. A value trap is a label for a stock or industry that's cheap based on metrics that analysts follow, thereby raising their allure, yet have declined for a more fundamental reason unbeknownst to investors. So someone who buys a value trap could lose money instead of capitalizing on an expected rebound.

Financial stocks in 2008 are a shining example. Lehman Brothers and Bear Stearns appeared like smart-money values prior to their collapse, based on expected earnings. Unfortunately, some investors were left in harm's way, not realizing the true extent of the balance-sheet toxicity.

Merrill Lynch recently introduced a model to help to identify a value trap. In its research, industries are ranked on three factors: price momentum (change in relative price over three months), earnings momentum (change in relative earnings per share over three months) and earnings yield (current relative forecast EPS divided by price).

Each industry is decile-ranked within each factor, and then the rankings are totaled. An industry is considered to be a value trap if it ranks within the top five deciles for earnings yield, but it scores below the fith decile on both earnings and price momentum. For an industry to be considered attractive, it must rank at decile six or better across each of the three factors.

To get a good feel for this model, I decided to re-create it, using data from TheStreet Ratings. I've maintained the same three factors with two small changes. For price momentum, I've used an average alpha score over the past three months, which is a bit different, in that it also accounts for risk (beta) when assessing the price momentum. And for valuation or earnings yield, I've compared the current earnings yield to the six-year average (Merrill uses a 10-year average).

As for the value-trap industries, there are seven, with the most notable being oil, gas and consumable fuels, capital markets, semiconductors and automobiles. There are 13 industries noted as attractive, with financial-related industries dominating the list, including the consumer-finance, diversified-financial-markets and insurance industries finishing in the top five.

Within the value-trap industries, I also looked for stocks that met the same sort of criteria. One note: For valuation with stocks, I used our proprietary valuation score, which looks at several measures. Here are stocks in the value-trap industries that look attractive from valuation measures, but have displayed weak price and earnings momentum.

Oil Gas and Consumable Fuels:
Forest Oil ( FST) -- Rated Hold by TheStreet Ratings
Sandridge Energy ( SD) -- Rated Sell by TheStreet Ratings
Marathon Oil ( MRO) -- Rated Hold by TheStreet Ratings

Computers and Peripherals:
STEC ( STEC) -- Rated Hold by TheStreet Ratings Hewlett Packard ( HPQ) -- Rated Hold by TheStreet Ratings
SanDisk ( SNDK) -- Rated Buy by TheStreet Ratings

Capital Markets:
Schwab ( SCHW) -- Rated Hold by TheStreet Ratings
Artio Global ( ART) -- Rated Sell by TheStreet Ratings
Credit Suisse ( CS) -- Rated Sell by TheStreet Ratings
Janus Capital ( JNS) -- Rated Hold by TheStreet Ratings
Deutsche Bank ( DB) -- Rated Sell by TheStreet Ratings

Containers and Packaging:
Boise Inc ( BZ) -- Rated Hold by TheStreet Ratings
Owens-Illinois ( OI) -- Rated Hold by TheStreet Ratings
Greif ( GEF) -- Rated Buy by TheStreet Ratings

Semiconductors & Semiconductor Equipment:
Kulicke and Soffa ( KLIC) -- Rated Hold by TheStreet Ratings
MEMC Electronic ( WFR) -- Rated Hold by TheStreet Ratings
ST Microelectronics ( STM) -- Rated Hold by TheStreet Ratings
Yingli Green Energy Holding ( YGE) -- Rated Hold by TheStreet Ratings

Automobiles:
Ford Motor ( F) -- Rated Buy by TheStreet Ratings

Electrical Equipment:
Enersys ( ENS) -- Rated Hold by TheStreet Ratings

Have any questions on these stocks or other industries on the list? Feel free to ask me here or on twitter at @bostoncfa.

Equity research manager Chris Stuart, CFA, joined TheStreet Ratings after working as a senior investment analyst with Merrill Lynch covering small-cap equity and alternative investment strategies. Prior to that, Stuart worked for One Beacon Insurance as an actuarial analyst and at H&R Block as a financial adviser. Stuart earned his bachelors degree in finance from the University of Massachusetts, Amherst. He holds a Chartered Financial Analyst (CFA) designation and is a member of the Boston Security Analysts Society (BSAS) and the CFA Institute.

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