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Knowing what the stock market will bring in 2025 is almost impossible. But there are some things investors like me can do to give themselves the best chance of doing well, no matter what.
One of these is staying out of value traps – stocks that look cheap but really aren’t. And avoiding this is my investment decision.
Value traps
There is more than one type of trap value. The most obvious type – and the easiest to avoid – are those where the stock looks cheap because the underlying business is in perpetual trouble.
With one or two minor exceptions, I’ve done a decent job of getting out of these types of stocks in the past. But unfortunately, there is a more complex type of value trap that is difficult to avoid.
Basically, investing is about buying stocks for less than they are worth. But this is not the only thing that matters – a stock trading below its intrinsic value can still turn out to be a bad investment.
If a stock is trading 20% below fair value, I expect the price will open sooner or later. But if it takes five years for this to happen, I’d be better off buying a tracking index FTSE 100.
Finding stocks that trade below their intrinsic value is not enough to make a good investment. Investors also need a reason to think that returns will come soon.
This is something I haven’t always paid 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 will unlock the hidden value in a stock before buying it. And this is something I’ve started to improve on.
FTSE 100 a conglomerate DCC‘s (LSE:DCC) is a good example. The company has divisions in energy, health care, and technology and I think the stock is not well known at the moment.
In terms of operating profit, the company managed to grow by 3.4% last year, which is modest. But the reason for this is that health care and technology units are both reported to be declining.
DCC’s energy business actually generated £503m in operating income and grew by 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 that the stock looks undervalued is not reason enough for me to buy. But management is planning to sell off its underperforming divisions to unlock this amount.
Since its balance sheet is healthy, the aim is to return the proceeds from the sale to investors as profit. And this will leave them with the energy business, which looks to have a bright future.
Accidents
There is, of course, a great danger with this strategy. Over time, divesting some units removes some of the diversification benefits of DCC’s shareholders.
That’s what I notice to continue with the stock. But my hope is to at least avoid the risk of having an unimportant stock that takes too long to recover.
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