Investors love undervalued stocks like consumers love bargains. When a stock is underpriced compared to its book value, it's practically on sale.
Here's a breakdown of what it means when a stock is undervalued (and how you can spot undervalued stocks in time to get in early).
Undervalued stock: Meaning and explanation
A stock becomes undervalued when its market value falls below its intrinsic value (aka true value). Analysts come up with a stock's intrinsic value through methods like a discounted cash flow analysis, PE ratio, or asset-based valuation.
A stock's true value is usually slightly different from its market capitalization, aka the total value of what its sold shares are currently worth in the market. However, when the market value is way above intrinsic value, analysts call out the stock for being overpriced.
What happens when a stock is undervalued? Ideally, it's more likely to experience future growth, which could mean capital gains for investors depending on their individual cost basis (or buying price). When a reliable analyst suggests a stock may be undervalued, their opinion could be worth listening to.
How undervalued stocks drive value investing
Oftentimes, investors can be divided into two main camps: Those who practice value investing and those who practice growth investing.
Value investors look for stocks that look underpriced compared to their intrinsic values. According to experts, value investing is winning against growth investing in the long-term war.
"From 1927 through 2019, according to the data compiled by Nobel Prize laureate Eugene Fama and Dartmouth professor Kenneth French, over rolling 15-year time periods, value stocks have outperformed growth stocks 93% of the time." — Dr. Robert Johnson, finance professor at Creighton University
What are the most undervalued stocks of 2021?
Here are some stocks that experts suggest are undervalued in November:
Intel (NASDAQ:INTC): While Intel stock is not necessarily trading at a discount, its potential is strong compared to its current valuation.
Delta Airlines (NYSE:DAL): Delta doubled earnings expectations in its latest quarter. Holiday travel could mean higher value to come.
American Express (NYSE:AXP): Despite the fact AXP is close to all-time highs, it still seems undervalued. American Express is also tied to travel thanks to its airline rewards.
Advanced Micro Devices ((NASDAQ:AMD): Demand is strong for AMD's semiconductor chips. The company can't keep up and its shares are trading at a discount.
Target (NYSE:TGT): When compared to the multiline retail industry, Target shares appear to be undervalued.
How to identify undervalued stocks with potential
Here are some ways to look for undervalued stocks:
Consider stock screeners like Morningstar to help streamline the undervalued stock discovery process.
A consistently high dividend yield is often a sign of an undervalued stock.
Find out if the PE ratio is low. If it is low, find out why. If there are no major issues causing a low PE ratio, the stock could be undervalued.
FAQs
A business is believed to be undervalued if its stock price is trading for less than one estimates its true worth to be, otherwise known as its intrinsic value. And this type of situation can happen when investors sour on a particular stock.
What does it mean if stock is undervalued? ›
An undervalued stock is defined as a stock that is selling at a price significantly below what is assumed to be its intrinsic value. For example, if a stock is selling for $50, but it is worth $100 based on predictable future cash flows, then it is an undervalued stock.
What does it mean when something is undervalued? ›
, un·der·val·ued, un·der·val·u·ing. to value below the real worth; put too low a value on. Synonyms: depreciate, underestimate, underrate. to diminish in value; make of less value. to have insufficient regard or esteem for; hold too low an opinion of.
What is an underpriced stock? ›
What Is Underpricing? Underpricing is the practice of listing an initial public offering (IPO) at a price below its real value in the stock market. When a new stock closes its first day of trading above the set IPO price, the stock is considered to have been underpriced.
What does it mean if a stock is overvalued? ›
What Is "Overvalued"? An overvalued stock has a current price that is not justified by its earnings outlook, known as profit projections, or its price-earnings (P/E) ratio. Consequently, analysts and other economic experts expect the price to drop eventually.
What makes a stock overvalued or undervalued? ›
The sales per share metric is calculated by dividing a company's 12-month sales by the number of outstanding shares. A low P/S ratio in comparison to peers could suggest some undervaluation. A high P/S ratio would suggest overvaluation.
How to identify undervalued stocks? ›
Price to Earnings Ratio
PE Ratio is one of the metrics used to identify undervalued stocks. The PE ratio compares the current market value of a stock with its earnings per share. Typically, undervalued stocks will have a low PE ratio. Remember that the standard PE ratio differs from industry to industry.
Does undervalued mean increase or decrease? ›
A financial instrument or security is said to be undervalued when its selling price is lower than that of its inherent value.
Should you buy a stock when it is undervalued? ›
One key benefit of investing in undervalued stocks is the potential for high returns. You may see substantial capital appreciation when the market eventually corrects and prices align with the stock's intrinsic value. Undervalued stocks often come with a margin of safety, reducing the downside risk for investors.
Is overvalued stock good or bad? ›
However, when the market value is way above intrinsic value, analysts call out the stock for being overpriced. What happens when a stock is overvalued? It's more likely to experience future volatility, which could mean capital losses for investors depending on their individual cost basis (or buying price).
Generally, undervalued shares are favored over overvalued ones, as the investors buy low and sell high. If the company is performing well, it can give promising returns. Buying an overvalued share doesn't have this advantage, as the price returns to its intrinsic value, which is lower.
Is Apple stock overvalued? ›
With its 3-star rating, we believe Apple's stock is fairly valued compared with our long-term fair value estimate of $160 per share. Our valuation implies a fiscal 2024 adjusted price/earnings multiple of 25 times, a fiscal 2024 enterprise value/sales multiple of 7 times, and a fiscal 2024 free cash flow yield of 4%.
What is the most overvalued stock? ›
The Top 5 Overvalued Stocks
- Wingstop WING.
- Celsius Holdings CELH.
- Southwest Airlines LUV.
- Vistra VST.
- Dell Technologies DELL.
Advantages of Undervalued Stock
Prices of undervalued stocks automatically return to their original value or intrinsic value, which is why profits are assured. It presents an opportunity to purchase shares at low prices from well-established or promising companies.
Is it good to invest in undervalued stocks? ›
Investors with a long-term investment horizon may find undervalued stocks appealing, as they have the patience to wait for the market to recognise the stock's true value. By holding undervalued stocks over the long term, investors can benefit from potential price appreciation as the market corrects its mispricing.
Is it better for a stock to be overvalued or undervalued? ›
When a stock is overvalued, it presents an opportunity to go “short” by selling its shares. When a stock is undervalued, it presents an opportunity to go “long” by buying its shares. Hedge funds and accredited investors sometimes use a combination of short and long positions to play under/overvalued stocks.
