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The stock market is the place where you can find unlimited companies listed from different sectors and industries. Traders pick the stock using technical analysis and some other parameters, but for investing you should find the stock that is undervalued.
Picking any stock randomly at any level or any price is not a wise decision. Stocks trading at the higher valuation don’t have potential to move significantly compared to an undervalued stock. High valuation stocks can fall down or correct due to traders profit booking correction. Hence, identify the undervalued stock that has higher possibility to give return.
To find the undervalued stocks you have to compare the stock price of different companies with valuation ratios and other factors like earning capability, return on fund invested etc. You can use various factors, but we have discussed here the best way to find undervalued stocks.
Intrinsic value is the actual or basic value of share price of a company or you can say it is the minimum valuation that a company deserves. If stock price of company is trading below its intrinsic value, then it is considered the share price is undervalued.
Many times either due to fundamental reasons or poor financial condition of the company, the share price of the company trade below its intrinsic value. The company is not performing well as per the expectations or running into the loss or operating or net profit margins is very thin.
However, despite all these things running well, the stock price trades below its intrinsic value, you can invest in such undervalued stocks that will recover or move higher with the improvement in the financial growth and other fundamental factors of the company.
To compare the overvalued or undervalued stocks, you can use certain parameters like operating profit margins, net profit margins. Moreover, you can also compare the current market price of the stock with book value and enterprise value or with EBITDA of the company.
Apart from that profit margins, debit and equity or liquidity ratio of the company are the popular ratios and parameters that can used to know if a stock is undervalued or overvalued.
To know if the stock price is undervalued or overvalued and compare with other listed companies you can find below the top ten best ratios and factors mostly used in the stock market analysis.
The ratios of price to the net earnings is very common and most popular factor most widely used to compare if valuation of share of listed companies. P/E ratio is calculated by dividing the current market price of share with the earnings per share (EPS). While you can find out the EPS by dividing the TTM net profit of the company by total number of outstanding equity shares.
And when you calculate the P/E ratios of the company, you can compare the same with industry P/E or with other listed peer group companies. If it is trading below the industry P/E of less than its listed peers, then it is considered an undervalued stock. If you find such undervalued stock you can buy at the lower levels and wait to justify its valuation.
Price to book value is another popular valuation ratio you can use to find the undervalued stock. It the share price of a company is running below its book value, and then it is considered undervalued. To find the price to book value, divide the last trading share price of the company with its book value. And to calculate the book value divides the total assets after deducting liabilities with total number of outstanding shares.
However, most of the share price of most of the listed companies’ trades above the book value but you should consider this P/B ratio when you evaluate the stocks of the financial companies or banks. If share price of these companies is trading below P/B ratio means the stock is undervalued. The P/B ratio is more than 1,it means the share price of the company is overvalued.
Return on equity is another useful valuation ratio to evaluate the stock price of a company. To compute the return on equity, simply divide the net profit of the TTM with equity shareholders fund. The value comes in percentage term and high return on equity ratio shows the company is earning the higher amount of profits on funds invested through equity capital in the company.
You can use this ratio to compare with its peer group companies, if ROE is high and the stock price of the company is low compared to its peer, and then it is considered as the undervalued stock. A company with a high ROE has a better capability to earn profits for its stakeholders, and if traded at a lower valuation, you can add such stock to your portfolio.
Dividend is that portion of net profit of a company that is distributed among the equity shareholders whenever a listed company declare its financial results, that is usually on every quarter. Divided on the face of each share, and paid directly to the shareholders as per their holdings in the .