As you know investing in value stocks is a great option for long-term investors as it carries minimal risk and yields huge profits. However, the value stocks can reap maximum benefits if you buy high-potential value stocks that are selling at a very low cost at a point in time and then trade it at the right time. The step to determine undervalued stocks is crucial and difficult at the same time. Many investors are not aware of how to find value stocks, and so they end sealing the wrong deal.
Generally, stocks are traded at a lower value because the market overreacts to certain news or due to other causes. A true investor is one who can find out the undervalued stocks. To ascertain which stocks have been undervalued, certain measures have proved efficiently beneficial to many businesses. In this post, we’ve enlisted some of the proven methods that can help in analyzing the stocks that are undervalued.
How to find value stocks?
Mentioned below are some of the finest methods to find value stocks
Value Stock depending on price/earnings ratio
This method is one of the most common methods used to ascertain the value stock that is undervalued. Though common, it does not necessarily give you the best results when used alone. You’ll have to club it with other methods for more precise results.
According to the price/earnings ratio, a higher price/earnings ratio indicates that the price of the stock is higher than earnings. In the same manner, if the price/earnings ratio is low then it is best to buy the stocks as it indicates a lower value of stocks. However, one has to be very careful as there can be several reasons behind the low price/earnings ratio. To make the right investment decision, it is necessary to ascertain why the price/earnings ratio is low. If the reasons are valid, then investors can go ahead to invest in the stocks.
Value Stock based on low debt levels
This is one of the best methods whereby the value of stocks is determined based on the debt levels of a particular company. According to this method, several companies have a large number of debts. These debts have high-interest rates, which lead to an inflated ROE. As the sales go down, debt-heavy companies slowly fall in more trouble. At a certain point in time, their value stocks may be undervalued. However, to make the right investment decision, investors should have complete knowledge regarding the debt to equity ratio. If the debt to equity ratio is below 0.5, then only the stocks should be considered as well protected, and investors can look forward to investing in them.
Value stock depending on price/earnings growth ratio
This method is more valued than that of the price/ earnings ratio. In this method, investors can take the price/earnings ratio and then divide it into the earnings growth rate. If the result is less than 1, then we can ascertain that investors are giving more priority to the past performance compared to future growth. It is very necessary to ascertain as an investor that all these are just projections and can have an adverse effect if not worked out. Always make sure to have an in-depth study on the stocks you plan to invest on.
Value Stock depending on the high dividend yield
Ascertaining the stock value with the dividend yield is a great way to find undervalued stocks. If a particular company’s dividend payment rate somehow exceeds the rate of the competitors, it means that the shares are undervalued. Furthermore, if the company is not facing any financial issues but its stocks are undervalued due to some reasons, then it is best to invest as the dividends can provide good returns in the short term. Furthermore, there are also fair chances for stock prices to rise in the future.
Value stock based on the low market to book ratio
This method is quite appreciated by many investors owing to its accuracy. This method states that a company that has low market value as a ratio to the total shareholders’ equity may be in an undervaluation situation. For example, a company has more value in assets compared to the running business capital. Then, it is best to invest in the company’s stock. As an investor, it is also necessary to ascertain the real value of both tangible and intangible assets. Investors are not able to ascertain the real assets of a company and they end up investing in the wrong stocks.
Value stock based on free cash flow
Sometimes, the free cash flow of a company can be used to find a great deal. Many investors analyze the free cash flow of business with undervalued stock to make an investment decision. For instance, the stock of a particular company appears to be low because of lower reports on earnings but the business has good cash flow. In such a scenario, you can invest in its stocks.
However, investors should use a screener or consult with the brokerage firm to ascertain the cash to share ratio. On the books, the reports might be different than actual. So you might miss a great opportunity if you avoid proper in-depth study regarding the original cash flow.
These were some tried-and-tested methods to find undervalued stocks. You can try one or all of these to make the right investment decision. It is however advised to even analyze the company’s performance meticulously before taking any final decision.