How to Select the Right Undervalued Stock
A short guide to determining the right undervalued stock for you.
- Price to Earnings Ratio
- Low Trading Volume
- Net Profit Margin
- Relative Strength
- Debt to Equity Ratio
- High Revenue Growth
An undervalued stock is a stock that is selling below its assumed intrinsic (or fundamental) value. The intrinsic value is determined by figuring the future income generated by the asset and discounting it to the present value. One key feature to look for with undervalued stocks is the steady increase of stock value. This value does not have to high, just steady. It is better to get a slowly rising stock than take chances on one that may be cheap but indicates a decline in stock value.
Price to Earnings Ratio
Locate a stock that has a low P/E (price-to-earnings) ratio. This indicates the stock's price over the last 12 months earnings. In other words, it is the price paid per share relative to the net income generated over the last 12 months. Record several of these stocks that you are interested in.
Low Trading Volume
Filter the stocks on your list by finding stocks that have a low trading volume. Trading volume is the number of shares transacted on a specific day. Higher trading volumes indicate that larger companied or investment firms may have found this stock and our investing large amounts of cash into it. As these stocks are purchased, the value of the stock will increase, which will lower the interest of someone looking for an undervalued stock.
Net Profit Margin
Filter your list even further by finding stocks that have a high net profit margin. A net profit margin is calculated as follows; Net profit margin = Net profit (after taxes)/Revenue X 100%. Typically this value is used internally by companies, but finding a stock with a high net profit margin can mean a solid management team is at work within the company.
Filter your list by stocks that have a low 12 month relative strength. These stocks are not jumping up and down throughout the year. They are increasing but at a slow, steady pace. A slow increase in stock value is what makes an undervalued stock worth the investment.
Debt to Equity Ratio
Filter your list with stocks that have a low debt to equity ratio. This goes without saying. You don't want to invest in a stock that is creating high amounts of debt instead of profit.
High Revenue Growth
Filter your stocks and find those that have a high revenue growth for the past several years. Again, when purchasing undervalued stocks, it is important to find those stocks that steadily increase over time.