Investing in undervalued stock could give you a portfolio boost of the market eventually favours them and they get a significant price appreciation. The concept behind value investing, initiated by Benjamin Graham and brought to the limelight by Warren Buffet, essentially means investing in stocks that are undervalued.
When shares are well below their average value, there will be a bargain buy for all kinds of investors. Payoff shows up when the price of stocks begin to rise as the market begins to favour them. By that time, investors will then have the opportunity to sell stocks at good rates. Looking to buy stocks? Click here.
How can one find an undervalued share? Let’s talk about that.
Tips to Find an Undervalued Stock
Finding undervalued shares requires special skills and know-how as the way the market operates is complicated. It requires a discerning eye since some stocks appear to be undervalued at times when they aren’t. This is seen as a value trap. To avoid value traps, check out these tips:
● Check out the Ratios
Several ratios can be very useful when it comes to assessing the values of shares. Some of these ratios include:
➔ Price-to-earnings ratio (P/E)
This is the ratio between a company’s stock price and its earnings per share sold. Earnings per share could be calculated by dividing a company’s profit by the number of shares sold. The higher the P/E, the higher the price of the stock.
➔ Price-to-earnings growth ratio (PEG)
The PEG ratio is simply a company’s P/E ratio divided by its growth rate for a certain period. A low PEG means that the market is discounting a stock’s potential to develop over a long time. That’s undervaluation.
➔ Price-to-book ratio (P/B)
This ratio is simply the price of a stock divided by its share’s equity. When this calculation results in a value less than one, it suggests that the stock is simply trading for much less than the total assets worth of the company.
➔ Current ratio
The current ratio is used to check out the financial health of companies. It’s derived by dividing a company’s assets by the liabilities incurred by the company, and it’s simply a way to measure how a company can control its debt obligations.
● Put Dividend Yield and Cash Flow into Consideration
Companies pay investors dividends, and these dividends represent a share of profits. Current cash flow and dividend yield are very important when an individual is looking to find undervalued stocks to invest in.
In terms of dividends, you mustn’t be distracted by the numbers you see. A strong dividend yield simply means the company is paying out a good profit at the moment, hence, you need to dig deeper. Specifically, you should consider the company’s cash flow, check for the company’s history, dividend and debts, is the current dividend yield sustainable? If it’s not, the company has undervalued stock.
● Compare Pricing of Different Competitors
This is quite straightforward, all you need is to compare similar companies in the industry. Here, an apples-to-apples comparison is the best, comparison between companies you think are undervalued and other companies that have their stocks fixed at high prices.
● Check Out the Financials
Candle-stick charts are capable of indicating a share’s level of volatility. When trying to find shares that are undervalued, it gives a complete picture of the company’s financial history, not just metrics like the ratios will give, but the full details. That means checking out the fundamentals concerning documents like the company’s balance statement, earnings report and income sheet. No doubt, you will know if the company has undervalued stocks from these details.
● Check Out the D/E (Debt-to-equity) Ratio
The debt-to-equity ratio simply means the amount of debt a company has actively divided by different stakeholders’ equity. A higher D/E ratio means companies rely on debt rather than the ability to finance different operations, but this should be actively balanced against cash flow, earnings, and assets when determining an undervalued stock.
Picking undervalued stock takes a lot of effort and commitment. The better you understand the basics of how stocks are identified, the easier it will be for you to make use of a value investing strategy to get your portfolio’s return to a higher level. The key is recalling that there are no rules for finding the right shares to actively invest and there’s always a certain amount of risk involved.