What to Look for in Undervalued Stocks

Brian Roy

Undervalued Stocks

Undervalued Stocks- Value Investing at its Best

Undervalued stocks are at the core of value investing, which is an investing strategy that involves investing in stocks that are selling for far less than its assumed intrinsic value. 

One of the staunchest supporters of undervalued stocks and value investing is billionaire Warren Buffet, who has notoriously made piles of money by buying stocks that others had overlooked.

To evaluate an undervalued stock, investors should look at the financial statements that are issued by the company, taking into account the company’s cash flow, profit retention, return on assets, and capital management.  This can help to put an intrinsic value on the stock that can be compared to the selling price.

Evaluation of Undervalued Stocks

Any true evaluation of undervalued stock will include a price-to-earnings ratio or P/E analysis.  This is a ratio that is used to initially find undervalued stocks in the first place.  In this equation, “p” stands for price and “e” for earnings. 

Thus, if a stock is trading at $40 a share and earned $2 per share in the past twelve months, then its P/E would be 20, which is 40 divided by two.  Generally speaking, the higher the P/E ratio, the bigger the potential the company has to earn in the coming years.

 Another important ratio when evaluating undervalued stocks is the company’s asset to debt ratio.  While this ratio is not the sole factor to consider for value investors, it does tell a lot about the company. 

For instance, if a company’s asset to debt ratio is low, it is a strong indicator that the company is running on credit to maintain its operations.  Undervalued stocks to invest in are those that own more assets than debts.

Finally, it is important to look at the dividend yield for stocks that may be undervalued.  A good yield percentage is typically something to watch for when buying undervalued stocks, since this means that the stock can be a money maker despite trading at a low share price.

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