In the crypto world, Bitcoin ranks among the most expensive crypto assets. Yet, affordable, lucrative investment opportunities that can deliver handsome returns lurk in the market. Likewise, you can find several beaten-down stocks in the market that can outperform in the long term. Finding undervalued stocks that could perform better either in the short-term or long-term will help you make profits.
What are undervalued stocks?
Undervalued stocks are stocks that are trading at a lower price than their perceived intrinsic value. In other words, the stock price does not accurately reflect the company’s financial performance, growth prospects, or other factors that could impact its long-term value. It is important to distinguish between undervalued stocks that offer potential for appreciation and penny stocks that are cheap but risky.
Why do stocks become undervalued?
Stocks can become undervalued owing to a variety of reasons but mostly linked to the supply- demand and market sentiment. The stock market is driven in part by investor sentiment, and if investors feel pessimistic about a particular company or industry, the stock price may decline even if the company’s financial performance is strong.
It is also likely that a company may be experiencing short-term issues, such as a dip in earnings or a temporary supply chain disruption that has caused the stock price to decline, even if the company’s long-term prospects remain bright.
Besides, there are several stocks that remain out of the reach of analyst coverages that can offer a better bang for the buck. These unexplored stocks could be undervalued as investors are not aware of the company or its growth potential.
Changes to the market
When a broader or sectoral index moves up or down, it can impact group stocks. Hence, even stocks that are not remotely connected witness price changes during market crashes or corrections in the valuation of an index.
Sudden bad news
Stocks move on news, and bad news can depress the price of a stock, turning it undervalued. Reasons can be a bad product, a bad review, negative media portrayal, or even economic and political coverages that leave a significant bad impression among investors.
Cyclical fluctuations
A cyclical stock is one that follows the economic cycle. For example, the stock price of an umbrella manufacturing firm surges in the monsoon season and witnesses a slack during the festive season. Generally, cyclical stocks are hit the most during an economic recession.
Misjudged results
The stock market, after all, is a game involving millions of minds, and it is difficult to time the market or guess the general flow of money. Stocks are likely to fail despite positive bets, and if they fail to beat the forecast, prices are likely to tumble.
How to find undervalued stocks
We have discussed various factors that can contribute to making a stock undervalued. A company with a weak management team or a history of poor decision-making can be undervalued, as investors are hesitant to invest in a company with such leadership. Certain well-followed metrics can also give you a heads-up if a stock is undervalued.
Price-to-earnings ratio (P/E)
The ratio measures the price of a stock relative to its earnings per share (EPS) and you can calculate it by dividing the stock price by the EPS. A higher P/E ratio typically indicates that the market is willing to pay more for each dollar of earnings.
Debt-equity ratio (D/E)
The ratio measures a company’s leverage, and one can find the ratio by dividing its total liabilities by its shareholder equity. A higher D/E ratio indicates that a company has more debt than its equity, which can increase its financial risk.
Return on equity (ROE)
The metric measures a company’s profitability relative to its shareholder equity. You can calculate it by dividing net income by shareholder equity. A higher ROE indicates that a company generates more profit per dollar of equity.
Earnings yield
The ratio measures the earnings per share of a company relative to its stock price. One can find the yield by dividing EPS by the stock price. A higher earnings yield indicates that a stock is relatively undervalued.
Dividend yield
This ratio measures the dividend paid by a company relative to its stock price. One can find it by dividing the annual dividend per share by the stock price. A higher dividend yield indicates that a stock pays investors a larger portion of its earnings.
Current ratio
This measures a company’s ability to pay its short-term liabilities with its assets. One can calculate it by dividing current assets by current liabilities. A higher current ratio indicates that a company has more short-term assets than short-term liabilities, indicating financial stability.
Price-earnings to growth ratio (PEG)
The ratio measures a company’s P/E ratio relative to its growth rate. You can determine the ratio by dividing the P/E ratio by the expected growth rate. A lower PEG ratio indicates a stock may be undervalued relative to its growth prospects.
Price-to-book ratio (P/B)
The ratio measures the price of a stock relative to its book value per share. You can calculate it by dividing the stock price by the book value per share. A lower P/B ratio indicates a stock may be undervalued relative to its book value.
Conclusion
Despite technological advancements and the best trading tools, timing the market is often a fool’s errand. While data could project rosy profits, markets may turn hostile, causing significant losses. Yet, some age-old investing lessons hold good in any market. Spotting undervalued stocks is one among them that can help you make substantial gains if you approach the evaluation process diligently. As always, DYOR.
FAQs
How to find undervalued stocks?
You can find an undervalued stock today by identifying specific sectors or companies that preliminary research suggests are likely to perform better in a given period. Once you identify the desired sectors and stocks, evaluate metrics such as the price-to-earnings ratio, return-on-equity, earnings yield, and other parameters for a peer-based analysis. This can help you identify undervalued stocks. However, investors should do research and take risk mitigation steps before investing in such stocks.
Is an undervalued stock a good buy?
Undervalued stocks can offer good investment opportunities if carefully chosen. They may have growth potential and provide a margin of safety, but thorough research and analysis are essential.
Do undervalued stocks exist?
Yes, undervalued stocks exist. These are stocks trading below their intrinsic value due to various factors. Investors often seek them for potential value appreciation opportunities.
Is Tata Steel undervalued?
The question of whether Tata Steel is undervalued or not depends on various market factors and individual analysis. It’s advisable to consult financial experts or conduct a thorough evaluation.
