How to Spot a True Value Stock (and Avoid Value Traps)

Value investing has been around for nearly a century, and it continues to be one of the most reliable strategies for building wealth over time. The principle sounds simple: buy a stock at a discount, hold, and let the market catch up. But in reality, not every “cheap” stock is a value stock. Some are simply broken businesses that trade low because their future is uncertain.

The real challenge for investors isn’t just finding cheap stocks — it’s identifying true value and avoiding value traps. Let’s break down how I approach it.

Valuation is the Starting Point, Not the End

When people think about value investing, they often start and stop with the P/E ratio. “It’s trading at 10x earnings, so it must be undervalued.” But that’s not always the case. A low multiple can signal an opportunity, or it can reflect a business in structural decline.

That’s why I focus on other signals: free cash flow generation, forward earnings expectations, and the strength of the balance sheet. These tell me whether the company is actually creating value for shareholders. I also like to compare current valuation to a company’s own history. If a business has been consistently valued at, say, 18x forward earnings for the last decade and today it trades at 12x, that discount may represent an opportunity — as long as the fundamentals haven’t deteriorated.

The Moat Matters

Cheap valuation alone doesn’t make a stock a buy. A true value stock also needs a moat — something that protects its market position and cash flows over time.

Think about UnitedHealth ($UNH). Its scale in managed care, diversified revenue across insurance, pharmacy benefits, and care delivery make it almost impossible for competitors to replicate. Or look at ASML ($ASML), which makes the lithography machines that every advanced chipmaker depends on. There’s no replacement. These companies may not always screen as “cheap,” but when their multiples compress, that’s when they become compelling value opportunities.

Value Doesn’t Mean “No Growth”

Another common misconception is that value stocks don’t grow. That’s not true. The best value plays often still have steady, predictable growth — the market just isn’t willing to pay a premium for it right now.

Take PayPal ($PYPL) as an example. The stock was hammered, losing more than 70% from its highs. But the business isn’t broken. Free cash flow remains strong, margins are stabilizing, and management is reducing share count through aggressive buybacks. Digital payments are still growing worldwide. This is a company with durable fundamentals, priced as if it’s in decline. That’s the essence of value.

Avoiding the Traps

Of course, not every “cheap” stock is a good investment. Some are cheap because they deserve to be. These are the value traps.

The red flags usually look like this:

• Declining revenue for several years in a row

• Unsustainable debt levels with no clear path to reduction

• Weak or negative free cash flow

• Management that constantly pivots strategies without real execution

If the core business is eroding, a low P/E or discounted multiple doesn’t matter — it’s just a mirage. The stock can stay cheap, or worse, go lower.

What True Value Looks Like

The best value stocks have three traits in common:

1. Healthy and growing free cash flow

2. A durable moat that protects their business

3. Stable, predictable growth, even if it’s modest

When those traits show up in a stock trading below its historical or intrinsic value, that’s when I get interested.

My Process and Why I Use Surmount

Even with a framework, value investing requires discipline. Emotions can get in the way — especially when the market is chasing the latest growth story. That’s why I supplement my own research with Surmount, a platform that runs automated, data-driven strategies built on proven signals.

Surmount gives me transparency into strategy performance, showing metrics like annual returns, max drawdowns, and long-term success rates. It removes the noise and forces discipline, which is exactly what value investing requires.

If you’re serious about leaning into value in the second half of 2025, I recommend checking it out: https://surmount.ai/strategies

Disclosure

This article is for informational and educational purposes only and should not be considered financial advice. The stocks mentioned ($UNH, $PYPL, $ADBE, $CNC, $UPS, $ASML, $SNOW) are discussed as examples to illustrate investing concepts and are not buy or sell recommendations. Investing in the stock market involves risks, including the loss of principal. Always do your own research or consult with a licensed financial advisor before making investment decisions. I may have personal or indirect exposure to some of the companies mentioned, but this article reflects my own opinions as of the date of publication.