Undervalued vs Overvalued Stocks
A stock is undervalued when its price is below what the business is really worth, and overvalued when the price is above it. The hard part is knowing the real worth.
Signs a stock may be undervalued
- A low P/E or P/B compared with similar companies.
- Strong, steady free cash flow for its price.
- Bad news that looks temporary, not permanent.
Signs a stock may be overvalued
- A price far above what profits support, even with fast growth.
- A PEG ratio well above 2.
- Lots of hype, with prices driven by excitement rather than results.
The value trap
A stock can look cheap because the business is shrinking. If profit keeps falling, a low P/E becomes high. Always ask why a stock is cheap.
Who decides?
Nobody knows for sure. The price is what the market agrees on today. Investors who estimate intrinsic value well, and are patient, can profit when the price moves toward it.
Related terms
Intrinsic valueWhat a business is really worth.
Margin of safetyBuying well below what you think it is worth.
P/E ratioHow many years of profit you pay for in a share.
Value investingBuying good companies for less than they are worth.
Growth vs value stocksFast growers versus cheap, steady companies.
PEG ratioP/E adjusted for growth.