2 dangerous value traps I’d sell immediately

Stay away – these market minnows are cheap for a reason.

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It takes a brave investor to consider purchasing some of the market’s worst performing shares in the hope that they’ll recover. Here are just two offenders from the small-cap universe that, despite their low valuations, I wouldn’t touch with a barge pole.

Game over

In November 2014, the shares of Game Digital (LSE: GMD) hit 338p. Fast forward to today and those very same shares have fallen 90%. Just why anyone would consider investing in the high street video game retailer in 2017 is beyond me.

Recent results tell you everything you need to know. In March, the £59m cap announced a 9.1% dip in revenue to £499m over the 26 weeks to the end of January compared to the same period in 2016. Pre-tax profits dived almost 27% to £16.5m and net cash from operating activities fell 61% to £25.7m.

With the popularity of online gaming making traditional consoles look increasingly outdated, I believe Game — which struggles to compete on price with online behemoths such as Amazon anyway — is a company in terminal decline. 

Aside from my concerns about where exactly it hopes to find and retain new customers, a quick look into Game’s financials is more than enough to put me off the company. Operating margins and returns on capital have fallen dramatically in recent years. Free cashflow? Don’t even go there.

Shares may be trading on just 11 times earnings (assuming EPS growth of 1.6% for the current financial year) but Game is one business that — in my opinion — is very unlikely to recover.

Posh flop?

Holders of Laura Ashley (LSE: ALY) surely deserve a bit of sympathy. The shares were trading around 24p this time last year. Today, you can pick them up for just over 10p – making it the sixth worst performing small-cap on the main market.

A quick recap of February’s interim results for the six-month period to the end of December and this kind of performance should come as little surprise. Back then, the company revealed a 3.5% drop in total like-for-like retail sales with pre-tax profits slumping 28% to £7.8m. At a time when any retailer worth its salt is growing digital sales at a furious rate, it’s interesting to note that online revenue remained almost flat at £25.6m (an increase of just £600,000 on the same period in 2016).

Looking forward, the Newtown-based business is expected to post a 52% drop in earnings per share for this financial year. Dividends are unlikely to be covered by profits and I wouldn’t be surprised if the company’s balance sheet — which once boasted a net cash position — becomes even more fragile. Returns on capital, which used to be so high, are falling rapidly. Free cashflow has dropped off a cliff and, thanks to its significant store estate requiring regular investment, I can’t see this recovering anytime soon.

As inflation rises and consumer belts tighten, Laura Ashley looks more vulnerable than ever. On eight times earnings, this presents as nothing more than a value trap.

Bottom line

When it comes to investing, buying cheap doesn’t always work out well, particularly in the ultra-competitive retail sector. For every company that manages to turn things around, you’ve got several more continuing to struggle or falling into oblivion. As far as I can tell, both Game Digital and Laura Ashley are prime examples of the latter.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Paul Summers has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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