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Finding Undervalued Stocks

By Edited May 27, 2016 0 0

Undervalued stock

Guideline for your Screening

It takes determination and a good level of intelligence to find and analyze stocks in a way so you can reap the benefits in cash. One way is to find undervalued stocks. Undervalued stocks are stocks that are trading at a price much lower than their true potential. What happens when the public finally realizes that this company is worth more than it seems? The price shoots up and continues to go up. This is a very specified way of trading called Value Investing. Famous investors such as Warren Buffett use this technique to invest in most of the equities he has in his portfolio. But how do you find the stocks that are undervalued and how can you be sure that these stocks are truly undervalued. Well that's the purpose of this article.

Finding a stock is not easy, a person can't go looking alphabetically through every stock and analyze each one. That is why a stock screener was invented. A stock screener is a tool giving the user the ability to find stocks under specified criteria. It is basically a list of all the stocks with a checklist to specify which stocks you want to see. There are many websites that offer free stock screeners, but the best one by far is FINVIZ. I love this screener it gives a lot more detailed criteria and also offers a chart of the stock with shown trend indications. To start off you will need to know what indicates a undervalued stock. (In my last article I have written a few basic fundamental terms which might help you) First you should decide which sector or industry to focus on in order to correctly fill out the requirements for you desired stock list. Every fundamental measurement is different for each industry so be careful. You cannot compare application software to agricultural chemicals.


P/E ratio

The first measurement you should use would be P/E ratio. P/E ratio measures Price relative to Earnings per share. It is a very important tool in measuring if the price to too overvalued or undervalued in comparison to the industry. Select the desired P/E ratio in the section. It should be low relative to the industry. But not too low because you might not find any stocks with a P/E ratio that low or with the other criteria that will be mentioned.

PEG Ratio

PEG ratio is a very important measurement because it shows how high the price to earnings is but also considering the company's growth over a 12 month period. P/E ratio isn't fully reliable because the P/E ratio will be higher for a company with a higher growth rate. Thats when PEG steps in. PEG takes growth rate into consideration so it gives a more reliable measurement for a stock's valuation. Like P/E, PEG varies per industry so make sure you have all your info before selecting a PEG number. The PEG should usually be under 1 for an undervalued stock, but check the industry standard just in case.

Sales Growth Past 5 Years

After finding stocks with the right P/E and PEG ratios it is time to search those stocks for sales growth figures. Sales growth is extremely important because it shows the general growth of a company. Now of course a company doesn't only rely purely on its sales but sales are a very important aspect for their success. Again the number you select should be appropriately adjusted from the industry averages. So if the industry average for 5 years sales growth is 5% per year than a good decision would be to choose above 10%. This will give you a list of stocks that have growth potential which is needed to find a true undervalued stock.

EPS Growth Past 5 years

Of course sales growth is only one part of the story, a company should be able to create a acceptable earnings growth as well. Earnings per share growth should also be selected with adjustment for the industry. Earnings represents sales subtracted by expenses and is  basically the same thing as net income. 

Return on Equity

Return on equity, a very important measurement should always be included in your search for a high potential stock. One of the most important measurements, Return on Equity, measures the management of the company, giving a percentage on the amount of money returned from shareholders' equity. Based on the industry the ROE should be relatively higher than its competitors to ensure you are looking for the best of the best.

Low Relative volume

When a stock is undervalued there is usually relatively less buying volume for that stock during the current time period. This is because undervalued stocks are seen as secondary stocks to the market performers. So there is little attention payed to them. This is when the volume begins to decrease. An indicator for this measurement is called Relative Volume. It measures how much volume is being traded relative to its volume x amount of time ago. Selecting the right number will give you the list of stocks that have been neglected and with their strong fundamentals, are due for a rebound.

 Performance of Stock

The performance of the stock (or the price fluctuation) should sometimes be less attractive compared to other competitors. This is because undervalued stocks are often times supposed to perform weakly until the public realizes their potential, which is when the performance strengthens. Which is why they are called undervalued.  There is an exception of course when a stock is rising but still considered undervalued, in which the stock will usually continue to rise. It is important to consider both options. Another scenario would be where the stock is trading in a sideways channel and not favoring either side. All these situations should be decided upon based on what knowledge you have at the time.




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