Undervalued Stocks

Investing in undervalued stocks is a good stock market strategy. Any stock is deemed as undervalued when it does not represent its actual value. This can be understood more clearly with an example. Consider a company that has 10000 dollars in plant and machinery, which generate annual profit of 1000. This company also has 5000 cash, and 10000 shares. The value per share would be 1.5 dollars, i.e., the value of plant and machinery plus the cash divided by the number of shares. However, this does not truly reflect the potential of the company. Suppose the 5000 dollars was invested elsewhere to fetch another 1000 per month. In such a case, the actual value would be much higher, as income is guaranteed in future! This is better income than the income the 5000 cash would generate by remaining in the bank.

When valuing the share, the stock brokers take into account the cash flows generated in future, and discount it, and bring them to present value. This discounted cash flow amount is then added back to the principal locked in plant and machinery and the 5000 cash invested elsewhere. The total amount arrived in this fashion is then divided by the number of shares, i.e., 10000 to arrive at the value of the shares. Effectively, any stock price quoted on bourses has the book value plus a value that is based on its potential.

Undervalued stocks can be found in stock markets using the Graham's stock selection technique. For understanding this principle, consider a business that has assets of 10000, liabilities of 2500, and 10000 shares. The book value of the share should be 7500/10000 or $0.75 per share. If the share prices are quoted below this, then the share is undervalued. This strategy has been further refined. If the stock prices fall right up to 2/3rd of the stock value i.e., 2/3rd of $0 .75, then it would be right time to acquire some of these shares. From here, when the 50 percent profit accrues on the investments, then 1/3rd of investment may be sold, and at 100 percent profit, the balance number of shares that help in taking away original investment may be sold. Graham's stock selection method is not the only way to make money on stock markets. There are other ways of analyzing undervalued shares as well. These include PEG analysis.

Stock markets tend to over react to any news that comes in the market, be it positive or negative. When the news is negative, the stock takes a plunge, and may reach a level that is closer or even less than its book value. It would, of course, recover from there, and therefore purchasing it at that point of time is the right way to go about investing in stocks. Other factors such as, low debt to equity, consistent growth rate, and adequate cash flows must also be considered before buying such undervalued stocks. Good undervalued stock will clearly have other parameters in perfect order, and is essentially down because of bad news.

Stocks can further be classified as undervalued based on comparison with other stocks in market, sector, or the ones with common characteristics. Therefore, there are undervalued small cap stocks, undervalued blue chip stocks, undervalued large cap stocks, and undervalued midcap stocks available in markets. Similarly, sector wise comparison is done to determine whether the stock in the sector is undervalued. Therefore, we have undervalued bank stocks, undervalued energy stocks, undervalued oil stocks, undervalued tech stocks, etc. Comparisons in dividends, and growth can indicate undervalued dividend stocks, and undervalued growth stocks. Raitos such as Price by earnings is used for such comparisons.

Stock prices have tumbled across the globe since their highs in 2007. Many stocks were therefore available at a great discount. In 2007, investing in stocks made more sense because such investment would eventually yield higher profit than bond market. In 2008, industry giants such as BankUnited Financials, and Franklin Bank lost a lot of ground, and were highly undervalued. In 2009, undervalued stocks can be found in technology sector.