What are some common traits of undervalued stocks?

By Ryan C. Fuhrmann AAA
A:

Investors usually use three primary techniques for valuing companies. The first is a comparative model where a firm’s stock market metric is compared to rival companies, or similar transactions where rivals have been bought out. The second is through a discounted cash flow (DCF) analysis where the firm’s future cash flows are modeled out, then discounted back to the future to get an estimated stock value. Finally, the cost model assumes the firm is liquidated and that any leftover proceeds are sent to shareholders. Here are the ways to tell if a stock is undervalued using these techniques.

Lower Valuation than Rivals

A company could be undervalued if it is trading below similar companies. For instance, if it has a lower price to earnings or price to book value than a rival, it could be a good deal. Of course, it could have lower profit margins, have higher debt levels, or be growing slower than rivals. The ideal scenario is to find a firm that is more profitable, growing faster, and more conservatively managed that is trading at a lower multiple of earnings or cash flow than the peer group.

Intrinsic Value above Market Value

The DCF approach is the essence of stock valuation. If the firm’s future cash flows per share are discounted back to today and the value is significantly above where the stock is trading at, then the stock is likely undervalued. Estimating the cash flows can take time, and the wider the value disparity the better, which helps offset the risk that the cash flow estimates were off or don’t turn out as expected.

The Company is Worth More Dead

If a firm’s book value per share, or shareholders’ equity divided by the shares outstanding, is above the current share price, then its stock could be undervalued. This is the theoretical value that exists if all of a firm’s assets were sold and the proceeds were used to pay off its liabilities. This leftover value would go to shareholders.

The Bottom Line

There are many ways to investigate if a firm is undervalued. Simply, if the firm grows faster than the market is expecting, or its current intrinsic value is not well represented in the stock price, it is possible an undervalued company is a good bet for some investors.

At the time of writing, Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.

 

RELATED FAQS

  1. What technical indicators can I use to find undervalued stock?

    Investors seeking new ideas may want to look to technical analysis to see whether the market has undervalued a particular ...
  2. What is the difference between fundamental and technical analysis?

    These terms refer to two different stock-picking methodologies used for researching and forecasting the future growth trends ...
  3. What are the best technical indicators to complement the Negative Volume Index (NVI)?

    Explore other technical indicators that can be used when designing a trading strategy that incorporates the negative volume ...
  4. What is a common strategy traders implement when using Moving Average Envelopes?

    Read about some of the most common trading strategies and signals you can use with moving average envelopes on an asset's ...
RELATED TERMS
  1. Undervalued

    A financial security or other type of investment that is selling ...
  2. Commercial Real Estate Loan

    definition of a commercial real estate loan
  3. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...
  4. Return On Investment - ROI

    A performance measure used to evaluate the efficiency of an investment ...
  5. Bidding Up - Securities

    The act of increasing the price an investor is willing to pay ...
  6. Bear Fund

    A mutual fund designed to provide higher returns when the market ...

You May Also Like

Related Articles
  1. Investing

    Use Breakup Value To Find Undervalued ...

  2. Investing

    Peer Comparison Uncovers Undervalued ...

  3. Get Rich Slowly found about the insights on investing from about 2,000 selected individuals by an online survey. Do they have an investing strategy?
    Investing Basics

    Do You Have An Investing Strategy?

  4. You need to be patient, diligent and perseverant to be successful at investing, but more importantly, you need to start early.
    Investing Basics

    Why You Should Start Investing Early? ...

  5. Investing on margin can be profitable but it's a risky play that needs care.
    Trading Strategies

    Margin Investing: Big Risk, Big Reward

Trading Center