There are many reasons why the price of a company’s stock is undervalued, meaning that its reflected price is not a true reflection of its ‘fair’ price or value. The reasons for these undervaluations could be due to a market crash, the recognisability of the company, or negative press.
With these types of undervalued stocks, the opportunity for making a profit arises through the market price corrections that are achieved over time. During this period, the price correction will be a better reflection of the company’s true value.
With the use of https://www.alphaspread.com/watchlist/most-undervalued-stocks, you are able to find those cheaper/ undervalued stocks. The trick here is to look for quality stocks that are priced under their fair value rather than just a cheap stock option. Good quality stock prices will inevitably rise over the long term, ensuring patient investors a healthy return.
Reasons for Stocks Being Undervalued
There are a number of reasons why a stock is undervalued, and these might include the following:
- Changes in the Market – prices are influenced by either crashes or corrections, each affecting stock prices in their own unique way.
- Sudden Bad News – negative press or tough economic times, as well as social and political changes, have an effect on prices.
- Cyclical Fluctuations – poor quarters during a business cycle can also be responsible for the undervaluation of stocks.
- Misjudged Results – when a stock does not perform as it has been predicted to, the price may take a bit of a dive.
Ways to Spot an Undervalued Stock
Undervalued stocks are determined through the use of ratios and make up part of their fundamental analysis. Here are the four most common ratios traders and investors use to determine a stock’s true value.
- Price-to-Earnings Ratio (P/E)
P/E is by far the most popular measure of the value of a stock. It indicates the amount you have to spend to make a $1 profit. P/E is calculated by dividing the price per share by the earnings per share.
- Debt-Equity Ratio (D/E)
D/E is a measure of the company’s debt against its assets. A higher ratio indicates that the majority of funding is done through lending and not its shareholders. D/E should always be measured against the competitors average.
- Return on Equity (ROE)
ROE is the measure of profitability against equity, done by dividing net income by owner equity. A high ROE could mean that the shares are undervalued, indicating a large income generation relative to shareholder investment.
- Price-to-Book Ratio (P/B)
P/B is used to assess the company’s current market price against the company’s book value, that being assets less liabilities, divided by the number of shares issued. The market price per share is divided by the book value per share. If the P/B ratio is lower than 1 there is a chance that the stock is undervalued.
Undervalued stocks, if worked and researched correctly, can be a gold mine if you have the patience and the aptitude for playing the long game.