The Worst Investments I’ve Made

As a long-time value investor, I pride myself on sniffing out bargains. But some of my worst investments have come from buying companies that looked amazingly cheap on paper only to discover deeper structural problems lurking beneath.

In particular, I’ve been burned by asset-heavy companies that sported low P/E ratios (Price-to-Earnings ratios) and strong cash flows, yet ultimately failed to deliver great returns.

To illustrate, I’ll share a few painful examples from my own portfolio – including a certain Japanese train manufacturer (my favorite industry, as readers know I’m a train enthusiast) – and the lessons I learned. Each of these cases taught me how seemingly “cheap” metrics can mask fundamental issues with scalability, cyclicality, and efficiency. Now, armed with those lessons, I’ve adapted my investing philosophy to avoid such value traps in the future.

Falling in Love with “Cheap” Stocks

Several years ago, I found myself drawn to stocks that looked objectively cheap. They had single-digit P/E ratios, solid revenues, and healthy operating cash flow. It seemed like classic value investing: buy at a low multiple, wait for the market to re-rate the stock upward. However, I learned that when a business is capital-intensive, a low valuation can be a warning sign instead of an opportunity.

Let me walk through what happened with three of my investments: Kinki Sharyo, Eizo, and Morita Holdings.

Kinki Sharyo: The Train Investment That Derailed

In the first case, my passion for trains led me straight into a value trap. Kinki Sharyo, a Japanese manufacturer of trains and railcars, had all the hallmarks of a deep-value gem. When I invested, its stock traded at a P/E of just 3×, an incredibly low valuation suggesting the market was practically giving it away. The company had a century-long history in rail, a solid export business (supplying projects from Cairo’s metro to Los Angeles’s light rail), and was generating healthy operating cash flow.

However, I learned that a low P/E can be deceptive. Kinki Sharyo’s business was extremely asset-heavy, it owns large factories and equipment to build trains, which means it isn’t easy to scale or pivot. Its home market in Japan is actually shrinking (fewer new trains needed as the population declines), so growth had to come from occasional foreign contracts.

This cyclical, project-based revenue meant boom-and-bust cycles: one year of high earnings (making the P/E look low) could be followed by lean years. Indeed, after a post-COVID earnings bump, the company had a 30-year high in profit yet still looked absurdly cheap, a classic value trap scenario. The catch was that those earnings were not reliably repeatable. Meanwhile, Kinki Sharyo’s heavy fixed assets (and the labor force to run them) made it hard to adjust when demand softened.

In hindsight, my love for trains blinded me to these structural weaknesses. The stock never delivered the gains I hoped for, as the market correctly sensed that the “cheap” valuation was justified by the company’s fundamental constraints.

Other Value Traps: Eizo and Morita Holdings

Kinki Sharyo wasn’t my only lesson…

Two other investments: Eizo and Morita Holdings – followed a similar pattern.

Eizo is a Japanese maker of high-end computer monitors. It had respectable cash flow and appeared cheaply valued when I bought it, with a single-digit P/E at the time and a track record of paying dividends. I thought its niche in professional monitors would protect it. But like many hardware manufacturers, Eizo is asset-heavy: it must maintain factories, inventory, and R&D labs. Its profitability turned out to be razor-thin. In fact, recent data showed Eizo’s Return on Assets (ROA) was barely around 1–2%. That’s extremely low. One reason was that any uptick in earnings was partly due to one-off boosts; for example, one year Eizo’s profit included a JP¥1.1 billion “unusual item” gain, which made earnings look better than the underlying reality. Once those temporary factors faded, its true earnings power (and stock price) languished.

Essentially, Eizo’s heavy capital requirements and intense competition meant it could never achieve high profitability despite looking “cheap” initially.

Morita Holdings, a manufacturer of fire trucks and emergency vehicles, taught me a similar lesson. This company often trades at modest multiples (a P/E under 10) and has steady revenue from municipal contracts. It sounded like a stable, undervalued industrial play. But again, the nature of its business is asset-heavy and somewhat cyclical. Governments replace fire trucks only so often, leading to lumpy demand. Morita must keep factories and skilled workers on hand even during slow years, which boosts its costs. Its ROA has hovered in the mid-single digits (on the order of ~5–6% in recent times), indicating it generates only about five cents of annual profit per dollar of assets, a sign of a capital-intensive operation. With high fixed costs and dependence on government budgets, Morita’s profit margins swing notably year to year.

What looked like a cheap stock ended up delivering mediocre returns as those structural headwinds kept the business from improving significantly.

Why Asset-Heavy Businesses Can Be Value Traps

So what do all these investments have in common?

They are asset-heavy companies – businesses that require a lot of physical assets (plants, machinery, etc.) and employees to operate. Over time I’ve realized that asset-heavy firms face intrinsic challenges that can turn a “cheap” stock into a long-term disappointment:

• Limited Scalability: Asset-heavy companies struggle to scale up quickly. To grow output or revenue, they must invest heavily in new equipment, factories, or labor. Unlike an asset-light software or service business, an industrial manufacturer can’t double its output without major capital expenditure. Growth is slow and expensive, and often linear rather than exponential.

• Cyclicality of Demand: Many asset-heavy industries are cyclical. Sales of trains, monitors, or fire trucks rise and fall with economic cycles or customer replacement cycles. A boom year can be followed by a downturn when customers tighten budgets. That makes earnings volatile, a low P/E in a boom can very quickly become a high P/E (or even losses) in a bust. I experienced this with the lumpy train and fire truck orders.

• Labor and Capital Rigidity: These businesses have large fixed costs. They can’t easily shed expenses when revenue declines. Factories, once built, still incur maintenance and depreciation. Skilled workers cannot just be let go without losing valuable know-how (and often labor contracts or practical needs prevent rapid downsizing). This rigidity means during downturns, expenses stay high even as sales fall, crushing profitability.

• Fluctuating Profit Margins: Because of the above factors, profit margins for asset-heavy companies tend to swing widely. In good times, high capacity utilization can produce decent margins; in lean times, under-utilized plants and aggressive price competition can erode margins to near zero. For example, even Kinki Sharyo’s peers like Nippon Sharyo have been forced to sell trains at discounted rates to fill orders, illustrating how thin the margins can get. Such margin volatility makes it hard for these “cheap” companies to consistently increase their intrinsic value.

In short, a low price-to-earnings ratio or a temporarily strong cash flow is not enough if the business itself is structurally constrained. The market rightly applies a discount to asset-heavy firms because their future earnings are uncertain and usually subpar relative to the assets employed.

Asset-Heavy vs. Asset-Light: Key Metrics Comparison

To put things in perspective, it’s helpful to compare some key metrics of asset-heavy businesses (like the ones I picked) versus more asset-light businesses:

• P/E Ratios: Asset-heavy companies often trade at low P/E ratios (single digits) because investors expect low growth and higher risk. Asset-light companies (for example, software firms or service providers) usually have higher P/Es, the market is willing to pay more for their superior economics and growth prospects.

• Return on Assets (ROA): Asset-heavy businesses typically show ROA in the low single digits (often under 5%), reflecting poor efficiency in turning assets into profit. Asset-light models regularly have double-digit ROA. (As a general rule, an ROA above 20% is considered asset-light, while under 5% is considered asset-intensive.)

• Profit Margins: Asset-heavy firms may have thin net margins (e.g. 5–10%) and those margins are very variable year to year. Asset-light firms can sustain higher net margins because of lower fixed costs, think of a tech company with 20%+ net margins versus a heavy manufacturer scraping by at a mid-single-digit margin.

• Cyclicality of Earnings: Asset-heavy earnings are more cyclical and unpredictable. Asset-light businesses, especially those with recurring revenue models or services in constant demand, enjoy more stable and predictable earnings streams. Investors reward that stability with higher valuations.

• Capital Needs & Scalability: Asset-heavy companies must reinvest a significant portion of cash flow into maintaining and upgrading physical assets (capex), which leaves less free cash flow for growth or shareholder returns. Asset-light companies need much less capital to grow; they can scale revenue with far lower incremental investment. This often leads to expanding ROA and ROE (Return on Equity) over time for asset-light firms.

This comparison underscores why a stock that looks cheap on traditional metrics might actually deserve to be cheap – because the business behind it is fundamentally less efficient and more risky than an asset-light counterpart.

How I Invest Differently Now: Focusing on ROA and Quality

My investing philosophy has evolved as a result of these hard-learned lessons. Nowadays, I don’t just look at a low P/E or a juicy cash flow in isolation: I dig deeper into the business’s quality and efficiency.

One of my key metrics now is Return on Assets. ROA tells me how effectively a company turns its assets into earnings. If a company consistently has an ROA in the low single digits, that’s a big red flag that it might be an asset-heavy value trap. I’ve set a mental threshold: generally avoiding any new investment with an ROA below 5% (unless there’s a clear catalyst for improvement). In practice, I much prefer businesses that can sustain double-digit ROA, which usually indicates they have some competitive advantage or asset-light model driving profitability.

Had I applied this rule earlier, I might have steered clear of my worst investments. Kinki Sharyo, Eizo, and Morita all had chronically low ROA figures when I bought them – a sign I overlooked at the time. Now I understand that a truly great value investment isn’t just about a cheap price; it’s about a decent business selling at a cheap price. By screening for ROA and other quality metrics (like healthy ROE, consistent margins, and manageable cyclicality), I aim to avoid “cheap but weak” companies and focus on those that are cheap and strong.

In conclusion, value investing is not just about finding low ratios – it’s about understanding why those ratios are low. My love for trains and industrials hasn’t faded, but I’m far more careful in evaluating the economics of those businesses.

A low P/E stock can be a bargain or a trap, and the difference lies in the company’s fundamental ability to generate returns on its assets. Going forward, I’ll keep chasing bargains, but with eyes wide open to the pitfalls of asset-heavy “value” stocks that aren’t truly creating value.

Sources:

1. Corporate Finance Institute – Return on Assets (ROA) Formula

2. KonichiValue Japan – Kinki Sharyo (7122) Analysis (June 2024)

3. Altay Capital – Cheap Japanese Portfolio Review (Dec 2024)

4. Yahoo Finance – Morita Holdings Key Stats

5. Simply Wall St – EIZO Earnings Quality Analysis

6. StockAnalysis – EIZO Corp. ROA statistic