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What is a good way to look for undervalued stocks? Related Questions

That is if you even believe in inefficient markets.

What are the ways to analyze stocks for a good
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How do I find undervalued penny stock in India?

Sowmay Jain, Investor & Blogger What are some undervalued stocks as of July 2014?
Updated Mar 16, 2016
What's a good place to look up stocks?

What are some of the undervalued stocks having a

fundamentally good base as of now?

Can you name one undervalued stock in the NSE? If

possible, can you share the reason why it is
undervalued?

Is finding undervalued stocks a good way to run a

hedge fund?

How do I find undervalued stocks easily?

What stocks are undervalued worthwhile investments

as of fall 2014?

More Related Questions

Question Stats

61 Public Followers
14,724 Views

Last Asked Mar 21, 2011

Edits

After reading above shot you may thought - "run out of market, it's crashing"
After reading above shot you may thought - "market is gaining, let's invest"

Buett follows opposite trend. Stay away from market when other are greedy
and invest when others are fearful.

Isn't it stunning, people buy when stocks goes high and restrain to buy when price
goes down. Do they like to buy expensive products or are they dumb enough to value
a product?

Always remeber, buy stocks as if you are buying groceries not perfumes.

In this answer we will examine ~ how value investors hunts cheap stock. How they
exploit the discrepancies of value and price.

Here, You'll nd illustration of 3 BSE stocks which will help you to nd out ~ how
you can pick up stocks like Warren Buett (world 3rd richest person) but let me
rst explain you two terms which I'm going to use further.

EPS is earning per share. It shows how much company's prot are available per single
share.

MPS depicts the current market price. It is the price at which stock is available for
trading in market.

#1) AXIS BANK

EPS - 34 (Avg)
DPR - 15% (Avg)
MPS - 415
How much does this share should be fundamentally valued?
It all depends on how much return you prefer. If you want 10% then the valuation will
change and if 15% instead of 10% then the valuation will decrease. But as a rational
being one will always invest where he can get maximum benet. 15% return are also
guaranteed by many mutual funds. So, instead of stock market, one will invest in MF.
Therefore we'll assume 20% return (which is highest among others) as a base to do
further calculation.

Let us take the desirable rate - 20%, the underlying value of the stock is equal to
capitalised value of current EPS i.e. 3420% which equates to 170 INR.
So in easy words company valuation is 170 INR per share and MPS is 415 which is
more than the double of valuation. It is overpriced by nerd mentality of traders. In
the words of value investor - stay away from it.

Remarks - Risky

#2) TATA STEEL

EPS - 65 (Avg)
DPR - 15% (Avg)
MPS - 288

Let us take minimum desirable rate - 20%, the underlying value of the stock is equal
to capitalised value of current EPS i.e. 6520% which equates to 325 INR.
So in easy words company valuation is 325 INR per share and MPS (current
market price) is 288 which is 37 less than its actual valuation.

Remarks - Buy it.

There is dierence between price (MPS) and value (EPS20%) in both stocks but Axis
bank is overvalued and Tata steel is undervalued.
Company ~ (EPS20%) - MPS = (-/+)
Axis bank ~ 170 - 415 = (-245)
Tata steel ~ 325 - 288 = (+37)

Why am I comparing two companies with dierent industries, one is nance

sector and other is related to infra structure?
Who cares where I invest, what matters is how much they give you on return. I'll only
care about how much I got in my pocket. It would have matter me when I can take
part in management of company which is not possible with class - B shares. So, as a
retail investors it doesn't matter whether you are comparing stock of dierent secter
or not.

#3) POWER FINANCE

EPS - 45 (Avg)
DPR - 20% (Avg)
MPS - 168

Let us take minimum desirable rate - 20%, the underlying value of the stock is equal
to capitalised value of current EPS i.e. 4520% which equates to 225 INR.
Even it distributed consistent dividends as you can see below,
So in easy words company valuation is 225 INR per share and MPS (current
market price) is 168 which is 57 less than its actual valuation.
It is far much better than Tata steel. Tata steel just gave you a margin of 37 INR
whereas it has margin of 57.
Even if you can perfectly predict that price will eventually decline then wait till it
decline. This is what known as Margin of safety. It is better to buy a product valued
100 for 80 but it's best to buy sane m same for 40 instead 80.

Here a quick example:- If you can buy a product available at 50% discount at your
nearby market (MRP 100) for 50 then you would have not been crazy. And next day if
the price declined to 25 then who the hell will not buy that product? (which is valued
at 100 and available at 25) Remember, the product's actual value is 100 and
discounted price is 25.
If it is a good deal then why you run out of market when it crashes. Instead you should
buy the shares at crashes as it the best time to get cheap deals at discount. Only the
dierence is that here nobody will tell about discount and at your nearby market they
will hang a board outside their shop.

Remarks - denately buy it

So now, we can conclude.......,

Axis bank - overvalued
Tata steel - undervalued
Power nance - highly undervalued

After reading this, many will discuss to their adviser - Whether you should buy power
nance or not? And absolutely they will say - NO.
Why? Because it is not highlighted by the media, TV channels etc. Nor their is
chances of hike in prices... Blah blah..

If the advise of experts is so much valuable then they would have been buying
stocks not selling their advise.
Don't think stock as a product which goes up and down instead you are buying a
business through marketable securities.

Best thing about stock market is that it gives you opportunity to purchase
expensive products at cheap rates but unfortunately some are unaware and some
knows but falter to take steps.

P.S. ~ You can also use your own method to value a stock as per your desire. If you
prefer to have money directly in your pocket then go for dividend discounting
method, and if you prefer to stick to a business for long time then use PBV method
and so on.
But always remember, your common sense to pick a business will help you more than
another statistics, well said by anonymous,

Note #1) ~ All the metrics are subjected to date 4th March.

Note #2) ~ Mr. Buett also use cash prot base. And here we used accrual prot. It will
not matter much.

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Alex Frey, CFA Charterholder. Founder of www.ivyvest.com and author of

A Beginner's Guide to Investing. Ten years inve...
Answered Mar 22, 2011
For a really quick rst cut, you can't beat Joel Greenblatt's screen at
http://www.magicformulainvesting... . This essentially screens for companies with
low price/earnings ratios and high returns on capital (essentially earnings / capital
employed in the business, with some modications). The logic is that screening on
p/e alone will pick up a lot of "toxic waste" - companies that are justiably "cheap"
relative to earnings because they do a poor job of deploying their capital. Cheap +
protable beats cheap alone.

On a sidenote, I wish Greenblatt hadn't called this "magic formula investing" because
it sounds hokey and he is actually a highly successful hedge fund manager with lots
of research to back his method up.

As another side note, if you had invested by this formula alone, you would have
thoroughly trounced just about every active mutual-fund manager over the last thirty
years.

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Lenny Grover, Founder/CEO of Screener.co

Answered Mar 25, 2011
Not to be contrary, but I disagree with the two posters above. I believe that Enterprise
Value divided by EBITDA is a much better valuation metric than P/E. It's just not
oered in all screening tools so users settle for P/E. Tell me which of the two
companies below is the more attractive investment:

1) Company X has a market cap of $1B, 0 cash and equivalents, and $10B in debt. In
the last year, they has earnings of $100M after paying $1B in interest and after an
eective tax rate of 0% (they had carry-forward losses that year). Their P/E ratio is 10
and their EV/EBITDA ratio is ~10.

2) Company Y has a market cap of $1B, $500M in net cash and equivalents, an
eective tax rate of 35% (no carry-forward losses) and earnings of $100M. Their P/E
ratio is also 10 but their EV/EBITDA ratio is <5.

Even though both companies have the same P/E ratio, they have dramatically
dierent EV/EBITDA ratios that clearly indicate that, all other things being equal,
Company Y looks like a better investment.

As a more perverse example, substitute $1B in net cash and equivalents for $500M for
company Y and the company still has a P/E ratio of 10 but you can essentially buy the
protable operating business for the company's own net cash!

(Begin shameless plug!) You really need to use a tool like https://screener.co to
determine which companies are undervalued. The few options available in the
screening tools from most retail brokerages, Yahoo Finance, or Google Finance are
inadequate to the task.

2.1k Views 4 Upvotes

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Rohit Jain, Founder, Investello.com

Updated Apr 29

First, we need to understand the meaning of the term undervalued. In the context
of stock market investment, it should mean a stock which should give you a very good
return in the future if you buy it at the current price. The reason I have dened this
seemingly obvious term is that its literal meaning is quite dierent from its intended
meaning.

The case of Value Traps:

There are a lot of stocks which consistently trade at a very low PE Ratio. Their price
has also remained lower than book value for last 10 years, and those stocks have never
given above average return to their buyers. Do we consider such stocks undervalued?
We may, but it won`t be of much use to the buyer. So now we discuss, how to nd a
stock which should give us an above average return in future in spite of seeming to be
overvalued. But rst, we need to understand that why do some stocks always trade
below their book value, and at a low PE ratio. Why does`nt market ever nd them
attractive enough to lift their valuations?

These kind of stocks are known as Value Traps

Lets consider an example of a value trap. The Stock Name is Dolphin Oshore. Here
is its Price vs book value Graph.
As can be seen from the above graph, in last 8 years, the price of Dolphin Oshore has
not moved much even though its book value has shown some increase. 8 years ago, it
was trading at a price very close to its book value, and its PE Ratio was 3.49. Today it is
trading much below its book value. What could be the reason?

Prot growth:

As we can see, Dolphins Prot has not grown at all in last 8 years. Even though this
company never posted a loss, it has failed to grow its prot. Market looks for growth.
The companies that are not able to grow their prot are valued low by the market.

This was just an example of one value trap, various kinds of value traps may exist.
Thus, We should analyse a company from all perspectives before investing

In order to avoid value traps by just looking at the valuations, we should analyse a
stock from following perspectives:

1. Safety: This is the most important metric. Safety of your capital should be
the rst priority of any investment strategy. This has been strongly advocated
by Warren Buet when he says Rule no.1 is Never lose Money and Rule no.
2 is Never forget the rst rule. In order to analyse the safety of investment,
one much look at the Debt Equity Ratio, Current Ratio, Income vs Operating
Cash Flow etc. All these terms have their own importance. Debt Equity Ratio
should be low, current ratio should be greater than 2 and OCF should go
parallel and more than Net Income.

2. Performance: This includes Return on Equity, Return on Capital Employed,

Net Prot Margin. Ideally Long term avg. RoE should be greater than 15%

3. Growth: Growth in Prot, Revenue and Dividend is a very important factor.

Market pays a premium over those stocks which register a nice growth in the
above metrics. Along with this, the growth in dividend should also be
considered. A company whose dividend growth is in line with Growth in Net
1
Prot isAsk
generally considered
or Search Quora a high quality Business Ask Question Read Answer Notifications Achint

4. Valuation: Lastly, it is very important to look at the valuations from the

perspective of various models. Looking at these models, you should consider
the valuation according to each of them and compare it with the price. If
price is too much in comparison of valuation, one must wait for correction
and not invest until correction happens.

A Business which is good from all the above factors, has a competitive advantage in
its sector and is fairly valued would give you great long term average return.

We can nd a lot of good quality businesses whose PE ratio is between 20 and 30, but
their prot growth is good and they have a competitive edge in market. Such
companies have always given above average return, i.e. close to 20% per annum. One
should look for such companies.

To conclude, I will end with a quote from Warren Buet, which is most relevant wrt
the above answer:

It's far better to buy a wonderful company at a fair price than a fair company at a
wonderful price.

Warren Buett

Edit: The above were quantitative factors that one needs to look at while selecting a
stock. In the answer to How can I nd stocks that are undervalued?, I have explained
the subjective factors that one needs to look at while selecting a stock for long term
investment.

PS: You can analyze Safety, Performance and Growth for any stock with last 10 year
Charts & Data for free over investello.com

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Pratik Parthe, Intraday trader, specializing in chart patterns

Answered Jun 23

There are a few factors which help us determine whether the stock is undervalued or
not. For e.g,

1. Market capitalization

2. P/E ratio

3. P/B ratio

Market capitalization:
It is the product of stocks current market price and the number of shares
outstanding. Higher the market capitalization costlier the stock to buy.

Market cap = Current market price * Number of shares outstanding

P/E ratio:
One the of the key fundamental ratios to determine what is market price of a share
with respect to its earnings.

P/E ratio = Current market price/Earnings per share

P/B ratio:
This ratio tells that what is price of a share with respect to the net worth of a company.

P/B ratio = Current market price/Book value per share

I use a technical screener called opportunity nder to analyse the value based
on P/E, market capitalization etc. Checkout the screenshot below:
Hope this helps.

|Follow me for a hassle-free trading life|

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Kritesh A
Answered Jun 24

There are a couple of nancial ratios that you can use to nd an undervalued stock.
Here are few:

1. Earnings Per Share (EPS) Increasing for last 5 years

2. Price to Earnings Ratio (P/E) Low compared to companies in same sector

3. Price to Book Ratio (P/B) Low compared companies in same sector

4. Debt to Equity Ratio Should be less than 1

5. Return on Equity (ROE) Should be greater that 20%

6. Price to Sales Ratio (P/S) Smaller ratio (less than 1) is preferred

7. Current Ratio Should be greater than 1

8. Dividend Yield Depends on Investor/ Increasing preferred

Read more here: 8 Financial Ratio Analysis that Every Stock Investor Should Know

Hope this answer is useful useful. Besides, if you want to read more on how to select a
stock, you can visit this post: How To Select A Stock To Invest In Indian Stock Market
For Consistent Returns?

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 Comment

Olivier Dambrine, 10th position national investor competition 2013

Answered Sep 10, 2015

You need to look for undervalued stocks, however watch out for value traps! These are
stocks that might be cheap if you only look at P/E or EBITDA yield, but they're going
nowhere. A lot of studies have shown that by combining momentum and value
factors in your model, you can signicantly improve your returns. In other words: buy
cheap stocks that have been going up for a while!

Our study has shown that the best performing models use a momentum factor as
primary factor and then use a secondary value factor to lter those results. All these
screens (including Greenblatt & Piotroski) can be generated very easily with the new
generation of screeners such as Value investing stock screener

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Adam Foroughi, Working on my next startup..

Answered Mar 22, 2011

As Stephen mentioned, price to earnings ratios are the right metrics to be looking at
but make sure you compare companies which are in the same industry since a low
P/E against the markets doesn't mean much. Certain industries carry lower P/Es than
others because the industry is high risk or lower growth potential.

Also remember that if company A and B are competitors and company A has a lower
P/E than company B that doesn't mean that company A is necessarily underpriced. If
all else equal it would be but you have to look at other things like growth rate, market
position, prospects, management team, etc.

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Alistair Bentley, Founder/ CEO of Simply Wall St

Answered Jan 28, 2015

If you want a screener that can look at an aggregate of dierent checks for
undervalued stocks try ours:

Simply Wall St - Potentially undervalued companies.

Also as requested by a number of users we have undervalued with dividend:

Simply Wall St - Potentially undervalued stocks that pay a dividend.

Basing a stock screen on a handful of metrics alone or 'X checks that Warren Buett
does' is awed as you miss out on the bigger picture.
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Stephen Alred Jr., Founder of Ignite Financial

Answered Mar 21, 2011

Use a stock screener (you can nd them anywhere, I use google nance) to weed out
high P/E ratios relative to a company's industry/sector. Then go from there by
narrowing down the criteria until you nd the stocks that are in sync with your
investing goals.

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