How do I know if a stock is undervalued?
Estimated EPS growth
Price-to-book ratio (P/B)
To calculate it, divide the market price per share by the book value per share. A stock could be undervalued if the P/B ratio is lower than 1. P/B ratio example: ABC's shares are selling for $50 a share, and its book value is $70, which means the P/B ratio is 0.71 ($50/$70).
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.
A critical aspect of CAPM is the concept of undervalued and overvalued securities. If the rate of return is greater than the expected return, it would be considered an overvalued security. If the rate of return is less than expected returns, it would be regarded as undervalued security.
By comparing a company's market capitalisation to its net asset value, the PB ratio assesses whether a stock is undervalued or overvalued. A PB ratio below 1 often signifies an attractive investment opportunity.
Undervalued is a financial term referring to a security or other type of investment that is selling in the market for a price presumed to be below the investment's true intrinsic value. The intrinsic value of a company is the present value of the free cash flows expected to be made by the company.
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.
The idea is that when the market cap is higher than GDP, the stock market is overvalued. If the market cap is below the GDP, the stock market is undervalued.
Typically, the average P/E ratio is around 20 to 25. Anything below that would be considered a good price-to-earnings ratio, whereas anything above that would be a worse P/E ratio. But it doesn't stop there, as different industries can have different average P/E ratios.
Relative Strength Index (RSI)
This indicator determines the strength of a stock on a scale of 0 to 100. The values above 70 are considered as overbought and values below 30 as oversold.
How do you know if a PE ratio is undervalued?
You generally use the P/E ratio by comparing it to other P/E ratios of companies in the same industry or to past P/E ratios of the same company. If you are comparing same-sector companies, the one with the lower P/E may be undervalued.
The undervalued stock is plotted above the required return, and also the overvalued stocks are plotted under the required return. As per the theoretical concepts, the investor can concentrate the undervalued stock for investment, and also, the overvalued stock can be sold-out.
To calculate the value of a stock using CAPM, multiply the volatility, known as “beta,” by the additional compensation for incurring risk, known as the “Market Risk Premium,” then add the risk-free rate to that value.
P/E ratio = P/E ratio / Growth rate of the company's EPS. Dividend-adjusted PEG Ratio / (Growth rate of EPS + Dividend paid). Financial experts consider a PEG ratio below 2 to be the threshold; above this, such stock is considered overvalued. Hence, the lower the PEG's value, the more undervalued it is and vice versa.
With its 2-star rating, we believe Apple's stock is overvalued 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%.
- ITC Ltd.
- Asian Paints Ltd.
- Sun Pharmaceutical Industries Ltd.
- Avenue Supermarts Ltd.
- Coal India Ltd.
- Varun Beverages Ltd.
- Eicher Motors Ltd.
- Bharat Electronics Ltd.
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.
It is said that stock is undervalued by 10%, which means that its current book value is at (100-10)% = 90%. Now, let the value of stock be x, and 90% of x = 18,000. Then, x = (18,000*100)/90. = 20,000. Now actual value of stock(i.e., 100%) = 20,000.
SNo. | List of Most Undervalued Stocks | Sector |
---|---|---|
1. | Avenue Supermarts Ltd | Retail - Department Stores |
2. | Coal India Ltd | Mining - Coal |
3. | Varun Beverages Ltd | Soft Drinks |
4. | Eicher Motors Ltd | Trucks & Buses |
Advantages of Undervalued Stock
It presents an opportunity to purchase shares at low prices from well-established or promising companies. These stocks also feature low risk due to the fact that such undervaluation is cyclical and the company has the potential to attain its intrinsic value.
What PE ratio is undervalued?
In general, if the company's current P/E is at the lower end of its historical P/E range or below the average P/E of similar companies, it may be a sign that the stock is undervalued—regardless of recent business performance.
With its 3-star rating, we believe Amazon's stock is fairly valued compared with our long-term fair value estimate. Over the long term, we expect e-commerce to continue to take share from brick-and-mortar retailers.
Fair Value Estimate for Apple
With its 2-star rating, we believe Apple's stock is overvalued compared with our long-term fair value estimate. Our fair value estimate for Apple is $160 per share.
Overvalued stocks are ideal for investors looking to short a position. This entails selling shares to capitalize on an anticipated price declines.
P/E 30 Ratio Explained
A P/E of 30 is high by historical stock market standards. This type of valuation is usually placed on only the fastest-growing companies by investors in the company's early stages of growth. Once a company becomes more mature, it will grow more slowly and the P/E tends to decline.
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