A Complete Guide to Identifying Undervalued Stocks

undervalued stocks

An undervalued stock has a market value below its intrinsic value, making it a great investment. The intrinsic value of a stock is influenced by many factors, including cash flow, assets, and liabilities. It’s difficult to determine the exact value of a stock, but stock metrics can help you figure out whether it’s a good buy or not. If you want to do a good deal, look for stocks that are both cheap and stable in value. If you keep an eye on the market, you can make big profits by buying undervalued stocks.

Interpreting stock metrics

Look for stocks on stock trading websites.

Good sites for this include Morningstar and Yahoo Finance. In the stock profile, you will find values ​​such as the current market price, cash flow, amount of dividends, equity ratio, and other important information. On such sites, you can view the price-to-earnings (P/E) ratio, price-to-book (P/B) ratio, dept-to-asset ratio, and view the 3rd-degree liquidity (current ratio). You can also find information on the company’s earnings and book value per share, total assets, and all liabilities.

Look for stocks with a low price-to-earnings (P/E) ratio.

The P/E ratio compares the current share price to the earnings per share. A low value indicates a cheaper stock. You can find P/E on many stock trading websites. If you still can’t find any information about it, you can calculate it yourself. To calculate P/E yourself, you first need to find earnings per share (EPS) by dividing the prior year’s total earnings by the number of shares. Next, divide the current stock price by the EPS value and get the P/E ratio. For example, if a company made a profit of €50 million and had five million shares, the EPS value would be €10. If the current stock price is $50 and the EPS is 10, divide 50 by 10. This gives you a P/E of 5. You should be careful to look for stocks with a P/E of less than nine. Note that typical P/E ratios can vary by industry. It can be higher in some industries than others, but that doesn’t rule out the possibility that the stock could still be undervalued.

Look for a price-to-book (P/B) ratio of 1 or lower.

This value compares the current share price with the book value per share. You can find the book value per share on the company’s books of accounts or on a website that provides information on stock trading. If the price-to-book ratio is below 1, the stock is undervalued. To get the P/B ratio, divide the current stock price by the book value per share. For example, if the stock currently costs $60 and the book value per share is $10, the P/B has a value of 6. The book value of a share is the share price as recorded on the company’s books. It is made up of the company’s assets and liabilities. Information on this is usually published in the shared profile.

Opt for companies that have a leverage ratio.

dept-to-asset ratio) of 1.1 or lower. Such a value means that the company has more assets than liabilities. It’s a sign that this is a strong company and a worthwhile stock. On stock information websites, leverage can usually be found in the stock profile. However, you can also calculate it yourself. Divide the company’s total debt by its assets to calculate its gearing ratio. For example, if total debt is $50,000 and total assets are $100,000, the company’s leverage ratio is 0.5.

Opt for stocks with a value of 1.5 or higher for liquidity 3.

Degrees (current ratio). This value compares a company’s assets to its liabilities. A score of 1.5 means the company has more assets than liabilities. Most websites indicate liquidity in the relevant stock balance sheet. To calculate the ratio yourself, divide the company’s assets by its liabilities. For example, if the company has assets of €75,000 and liabilities of €50,000, 3rd-degree liquidity is 1.5. Assets include all of the company’s possessions that produce value. Liabilities are those assets of the company that are likely to decline in value, including debt.

Select a profitable and stable value share

Choose a stock with a Standard and Poor’s (S&P) quality rating of at least B+.

Standard and Poor’s is a large financial company that runs several major stock indexes. This company’s valuations are considered the gold standard in the financial industry. Ratings range from D (for poor-quality stocks) to A+ (for high-quality stocks). A B+ rating suggests the stock is stable and likely to increase its value. You can check the quality rating on S&P’s website.

Analyze the company’s cash flow.

It is often undervalued if a company has positive cash flow and a low price. Check the company’s cash flow reported in the stock profile. Compare current cash flow to previous quarters or years. Look for cash flow that has remained constant or increased. Avoid stocks with negative or declining cash flow. Cash flow indicates how much money the company owns. Positive cash flow could indicate that the shares have higher liquidity, meaning you can more easily sell them back if you need to.

Check if the company pays dividends.

Dividends are small annual payments made to the company’s shareholders. Dividends allow you to make a small profit while waiting for your undervalued stocks to become overvalued. Look for stocks that pay consistent or increasing dividends each year. To see if a stock pays dividends, look at the stock profile for dividend yields. If the company has reported a dividend yield, it pays dividends.

Find undervalued stocks

Thoroughly examine a market sector to see which stocks are undervalued.

Different industries have different characteristics of success. If you focus on one or two industries, you will learn how different market areas will develop over time. Eventually, you will find it easier and easier to find undervalued stocks. For example, companies in the software industry have an average P/E ratio of 70, while that of hardware companies is between 15-20.

Buy stocks when there is a stock market crash or market correction.

Many investors sell their stocks when the market falls to minimize their losses. Many stocks of normally profitable companies could be undervalued during this period.

Check the stock price after a disappointing quarter.

If you hear that a company didn’t meet expectations for the quarter, its stock could fall. This could result in the stock being undervalued for some time. If the company has a solid history and has a good rating from S&P, it’s still a good idea to buy shares. Follow each company’s trends on financial websites and in the news. If a company has not lived up to its expectations, it could be in the news.

Use an internet-based stock screener to find undervalued stocks.

Online tools like the Google Stock Screener or the Yahoo Stock Screener allow you to set specific criteria to search for stocks. You can filter by specific price-to-earnings and price-to-book ratios, desired liquidity, and other factors. The tool will then only show you the stocks that meet these criteria. For example, you can have the tool look for stocks that have a P/E of less than 20 or a P/E of less than 5.

 

Frank Reid

Frank Reid is Usevoucher Contributing Writer. He covers a wide range of topics, including financial planning, car reviews, travel, entertainment, and lifestyle. He has an extensive journalistic background, where he's written and reported for several newspapers and magazines. Frank lives in New York, and is a native of Texas.