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Finding undervalued stocks is a great way to give your portfolio a long-term boost. A basic understanding of stock valuations can give you the upper hand when it comes to making strong, forward-thinking investment decisions. Using these skills to your advantage will improve your chances of becoming a successful investor by making sure you’re not overpaying for shares.
What is an undervalued stock?
An undervalued stock is when a company’s market share price is trading below its “intrinsic” or “assumed” value. It means you are paying a “fair” or “cheap” price for a stock that could arguably be valued at a higher level based on its current fundamentals. This method of assessment forms the backbone of value investing. A strategy used by the likes of Warren Buffett.
What does undervalued mean?
This term refers to the underlying value of an asset or stock. Calculations are used to try to figure out a stock’s intrinsic value. Basically, how much the company is really worth. If the market price of an asset is trading below its intrinsic value, it may be thought of as undervalued or cheap. Different methods can be used to calculate an asset’s intrinsic value, which is why valuations are sometimes subjective.
Who decides if a stock is undervalued?
Unfortunately, there’s no single authority that declares when a stock is undervalued. Although most investors and analysts tend to look at the same metrics, there are often debates about what the market price of a stock should be.
There are also some industries that are harder to judge than others. For example, determining whether a tech stock is overvalued or undervalued is much more difficult than it is for consumer or industrial stocks. This is because tech stocks often have fewer tangible elements that can be measured to determine their intrinsic value.
How do you see if shares are undervalued?
There are a few basic metrics you can look at to get an idea about whether a stock is undervalued. Some of the key measurements you should check include:
- Price-to-earnings (P/E) ratio: The P/E ratio is a solid place to start because it gives investors a decent overview of a stock’s value. Lower is better when looking for value.
- Price-to-sales (P/S) ratio: A low P/S ratio can be more helpful to evaluate stocks with inconsistent earnings. For example, tech companies.
- Price-to-book (P/B) ratio: Not as useful for tech or software firms. But, a helpful measure when looking at stocks with lots of assets such as banks or financial institutions.
- Price-to-earnings growth (PEG) ratio: This is an advanced version of the P/E ratio and allows you to factor in past growth of the stock.
- Dividend yield: If a stock’s dividend yield is much higher than in the past, this could mean the stock is undervalued.
When trying to figure out if a stock is undervalued, you will want these ratios to be on the lower end of the spectrum. There are also plenty of other measurements you can use. But some will and won’t be applicable to certain types of stocks.
It’s also a good rule of thumb to use the same metrics when comparing companies in the same industry, or stocks that share a similar business model. Otherwise, you could end up comparing apples with oranges.
Where can I find undervalued stocks?
Most stock markets across the world will contain at least some undervalued stocks. However, there’s no definitive list out there naming all the undervalued stocks you can buy. This is because it’s not always a straightforward assessment. And, stocks in different industries tend to be judged in various ways.
Once you’ve grasped the basics of finding undervalued stocks, that’s when the fun begins. You can start searching high and low to find unloved shares and stocks that have been overlooked and undervalued by others. Just remember that an undervalued stock may be trading below its intrinsic value for good reason.
How to buy undervalued stocks
Here’s a simple step-by-step guide you can follow if you’re looking to buy undervalued stocks:
- Sign up to a share dealing platform: To buy undervalued stocks and shares, you’ll first need to open a brokerage account and deposit funds.
- Research undervalued stocks: Valuations will adjust on a daily basis and you can use many methods to assess stocks, coming to your own conclusions about value.
- Decide how much to invest: Make sure that the stock fits in with the rest of your investment portfolio, then choose how many shares you want to buy.
- Buy the undervalued stock: After you’ve researched a stock and decided it to be undervalued, you can place an order to buy shares.
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Are undervalued stocks popular?
Yes and no. There are two sides to this coin. Undervalued stocks are often unpopular for one reason or another, which is why they may be trading below their intrinsic value. Yet, undervalued stocks are popular among certain individuals like value investors who are specifically looking for these types of investments.
Can I make money with undervalued shares?
Yes, this is definitely possible but there are no guarantees. Just because a stock is considered undervalued doesn’t necessarily mean that the share price will ever reach a fair value.
There may be other factors leading to its undervaluation. So, it’s important to keep in mind that even if everyone believes a stock to be undervalued, you may not make money. Or, you may have to hold onto the stock for a long time before its market value adjusts to a fairer price.
Who sells undervalued stocks?
Undervalued stocks can be found in just about every stock market in the world. You should be able to access at least some undervalued assets through your share dealing platform.
However, having access to a wider range of stocks and markets can open up more investing opportunities. This is why it’s often useful to have access to a brokerage account with a large choice of shares to invest in.
When does a stock stop becoming undervalued?
This will depend on what metrics you’re using to determine a stock’s fair valuation. Also, your definition of undervalued may be different to that of other investors. Valuations of stocks can be quite specific to individual investors’ goals and perceptions of a particular investment.
Should every investor buy undervalued stocks?
Finder’s investment expert Zoe Stabler answers
Not necessarily. On the surface, it makes sense that we should all be paying a low price for shares. But the reality is slightly more nuanced.
Some investors may look at a stock and think it’s undervalued. Yet, the share price could lag behind its fair or intrinsic value forever. Similarly, a stock may be thought of as overvalued by many, but the share price can continue to grow regardless.
Undervalued stocks can be useful in some portfolios. But, determining the value of some businesses can be tough. You could miss out on some excellent investments because you’re too hung up on valuations. Ideally, you never want to overpay for stocks and shares. But sometimes it is unavoidable.
With some simple and straightforward research on your part, you may be able to find undervalued stocks and shares that provide some excellent investment opportunities.
But it’s important to remember there are downsides too. It may take a long time for a share price to reach its fair value. Or it may never happen at all. Undervalued shares could be an investment opportunity to grab with both hands, but there may be valid reasons for the cheap prices. So always make sure you tread carefully before diving in.
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