Undervalued stocks are shares with a market price significantly lower than what their actual value should be. The value of a company is based on certain fundamental financial indicators, such as its cash flow, profits, return on assets, liabilities, etc.
For various reasons, the market price of a share may not accurately indicate the current value of the company. For instance, smaller companies not on the radar of analysts and investors may be experiencing growth in sales and profit, but it may not be reflected by an increase in their share prices.
There are many such reasons why a company’s stock is trading at a value lesser than its true value.
Key Indicators for Figuring Out the Undervalued Stocks in India
Here are some of the important factors to look into while learning how to identify undervalued stocks-
Price to Earnings Ratio
PE Ratio is one of the metrics used to identify undervalued stocks. The PE ratio compares the current market value of a stock with its earnings per share.
Typically, undervalued stocks will have a low PE ratio. Remember that the standard PE ratio differs from industry to industry. Comparing an IT company’s PE to a manufacturing company’s PE ratio to judge the stocks are undervalued would be misleading.
Impact of News
Good and bad news both affect the stock market by changing the public’s perception of a company.
Sometimes, bad news can lead to stocks becoming undervalued for a short period even though their financial fundamentals remain strong.
PEG Ratio
The price/earnings to growth (PEG) ratio establishes a relationship between the PE ratio and earnings growth. PEG ratio checks if a company’s share price is undervalued or overvalued by analyzing a company’s current and expected earnings growth rate.
PE ratio does not show a company’s future earnings growth; hence many consider the PEG ratio as an evolved/modified version of the PE ratio. Hence, if the PEG ratio of a company is low, it is probably one of the undervalued growth stocks in India.
Change In Fundamentals
In some situations, when there is a change in the fundamentals of a company, such as a positive change in its management, it won’t always immediately reflect in its stock price. There might be a time lag before the share price.
Free Cash Flow
Free cash flow (FCF) is another metric that can be used to check if a stock is undervalued. FCF is the cash that a company generates through its businesses and operations after taking care of the expenditures.
Cash flow, to a certain extent, gives us an idea of the company’s ability to fund operations and capital expenditures. Often companies use their cash flow to give out dividends and share buybacks.
This is the reason why many consider cash flow as a value metric. If a company is trading at a lower value and cash flow is rising, there may be chances that shares are undervalued and may have future chances of growth.
The Disruptiveness Of the Business Model
Identifying the potential of new companies as well as the underdogs in the industry is another way to find undervalued stocks in India. Look at the companies offering disruptive products and services in the industry or creating a new market or market channel.
Price to Book Ratio
The price to book ratio compares a company’s current market value or market capitalization to its book value.
Often, a company could own a lot of property that’s worth a lot more than the profits it generates from its primary business operations. Hence, even though its financials are strong, the price of its stock might not reflect it. The key is to look at the assets and liabilities of a company holistically.
