Signals of Stock Is Undervalued
You can calculate the intrinsic value of the company and compare with the current price.
Key Points
A common way is to compare it’s P/E ratio with similar firms in it’s peer group. Other things being equal, if a stock is trading at a lower multiple than a similar one than it is probably undervalued. Or the other is over-valued.
If you’re not familiar with the ratio it’s just current market price divided by Net income. I would also consider calculating the ratio using EBITDA instead of NI for the company and its peers and see how this correlated with the current price,
There are other ways but finding a stock that’s under valued is easier said than done. The market might not be completely efficient but smart people are paid a lot of money to find good values and they have top-notch software and analytics at their disposal.
Be careful using calculations with Net Income as a component, it is easy to manipulate this number to make the financials look better than they are. Tax rate, depreciation, interest expense all can be manipulated to affect NI.
Signals of Stock Is Overvalued
When a stock’s current price does not correspond to its P/E ratio or earnings estimate, it is considered overpriced. If a company is priced at 50 times earnings, it is likely to be overpriced when compared to one priced at 10 times earnings.
Some believe the stock market is efficient. They’ll claim that stock prices take value into account almost immediately. Others, such as fundamental analysts, believe that there will always be undervalued stocks in the market since individuals occasionally invest based on their emotions rather than reasoning.
