Are These Two Cheap Stocks Actually Traps?

Investors who go for stocks with cheap-looking quantitative valuation metrics sometimes get burnt by value traps.

A value trap is a stock that looks cheap on the surface but is actually experiencing a decline in its intrinsic worth over time. Such stocks can be dangerous because a share’s price is ultimately governed by its value over time.

Finding value

One popular valuation metric that’s used to find bargains in the stock market is the price-to-book (PB) ratio. A share with a PB ratio lower than 1 can be thought of as a potential bargain since investors can theoretically recover more in value than what they paid for the share if it liquidates its entire business and settles all its obligations.

In light of that, Indiabulls Properties Investment Trust (SGX: BESU) and Otto Marine Ltd (SGX: BER) certainly look cheap – at least on the surface. At their current share prices of S$0.225 and S$0.28, respectively, they’re valued at just 0.13 and 0.18 times their latest book values.

For some context, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund mimicking the fundamentals of Singapore’s market barometer, the Straits Times Index (SGX: ^STI) – has a PB ratio of around 1.2 at the moment.

The destruction of value

But, there may be good reasons why Indiabulls Properties Investment Trust and Otto Marine are trading at such depressed valuations.

India Bulls and Otto Marine's book value

Source: S&P Capital IQ

As you can observe in the chart above, both stocks have seen their book values fall steadily over time since December 2012. In other words, their intrinsic worth has been shrinking over the past two-plus years.

A Fool’s take

Both Indiabulls Properties Investment Trust and Otto Marine look really cheap now. But, it’d pay for investors to dig deeper beneath the surface before any investing decision is reached. If both shares’ businesses can’t improve materially, then they may just become value traps.

Investors would need to be aware of the risks involved with the two shares despite their enticing valuation.

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.