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. Are small cap companies more risky investments than large cap companies?

    Learn about the risk of small cap companies compared to large cap companies. Compare the volatility of both and learn how ...
  4. Is it possible to be perfectly hedged against risk?

    Learn what it means to mitigate the market risk of a portfolio through hedging and to what extent hedging can reduce downside ...
RELATED TERMS
  1. Undervalued

    A financial security or other type of investment that is selling ...
  2. Indicator

    Indicators are statistics used to measure current conditions ...
  3. Intraday Momentum Index (IMI)

    A technical indicator that combines aspects of candlestick analysis ...
  4. Smart Beta

    Investment strategies that emphasize the use of alternative weighting ...
  5. Investment Crowdfunding

    Investment crowdfunding is a way to source money for a company ...
  6. Commercial Real Estate Loan

    definition of a commercial real estate loan

You May Also Like

Related Articles
  1. Technical Indicators

    What technical indicators can I use ...

  2. Investing

    Peer Comparison Uncovers Undervalued ...

  3. Investing

    Use Breakup Value To Find Undervalued ...

  4. Investing

    What is the difference between fundamental ...

  5. Term

    Undervalued

Trading Center