If you’re new to stock investing, you want to make sure that you only invest in those that have a high potential for growth and return — and that’s okay. Of course, no matter what other people say, the best way to measure success in this type of journey is based on how much money you put out and how much you get in. 

If you go on the internet ready to start your first stock investment, you’ll probably use keywords like “Stocks with best value” or “Stocks with most profit.” But if you’re already an experienced investor, you know that you don’t always have to go for the popular ones. You’re probably familiar with “undervalued” stocks. 

What exactly are “undervalued” stocks, and how do you find (and invest in) them? We’ll find that out and more in this post. 

Undervalued Stocks: Definition

In simple words, an undervalued stock is just like what it sounds like — one that appears to be trading below what investors consider to be a fair price for it. As part of a value investing strategy, investors often look for undervalued stocks. However, some investors may also think that some growth stocks are undervalued.

For example, something might be undervalued if it’s worth $100 but is on sale for $75. In the same way, an undervalued stock trades for less than what it is worth.

Why Stocks Become Undervalued

Now, the question is — why are some stocks considered “undervalued”?

According to experts, stocks can be undervalued because they are dragged down by their sector or the overall market. In reality, companies with such undervalued stocks typically have strong balance sheets, good net free cash flow, and a promising future outlook that are yet to be discovered.

An example could be Qualcomm, according to Daniel Milan, managing partner of Cornerstone Financial Services in Southfield, Michigan. This company has suffered along with the overall tech sector, but within semiconductors, it is frequently overlooked on its own.  However, it is trading at a higher discount than its peers.

Another reason a stock may be considered undervalued is that investor demand has shifted to other areas, such as if a particular sector becomes popular, causing prices to rise. Meanwhile, a lack of demand for stock in another sector could dampen share-price growth, even if these companies’ underlying financials remain strong.

In many cases, undervalued stocks are mature companies, so there may not be as much excitement and belief in their long-term growth prospects.

What’s In It For You As An Investor

So what exactly does this mean for you as an investor? Why do you need to know what undervalued stocks are? 

If you know what undervalued stocks are, you might be able to make better investment choices.

People may look for stocks that they think are undervalued based on their own research, advice from a financial advisor, news articles, etc. Or, they could put their money into funds whose goal is to find undervalued stocks.

But other investors might choose to invest in different ways. Even if you agree that a stock’s price is too low, that doesn’t mean it’s the best investment for you.

Maybe you think a stock is undervalued by 5%, and when it comes back to what you believe is a fair price, you don’t think the company has much growth potential. On the other hand, you might think that investor demand will cause the stock price of a new technology company to rise by 100% in the next couple of years.

So maybe you’d rather invest your money into a growth company, even if you don’t think the share price is fair. Overall, many investment decisions depend on several things, such as your risk tolerance, how long you plan to invest, and what you think about investing.

How To Find Undervalued Stocks 

There are dozens of ways to find stocks that are undervalued. An essential rule of thumb is to make sure that no single stock makes up more than 10% of your portfolio.

1. Check the price-to-earnings ratio and market cap of the company.

The price-to-earnings ratio, or PE ratio, is one way to find stocks that are worth less than they are worth. To determine the PE ratio, you divide the stock price by the company’s earnings per share. 

To find a company’s earnings per share, divide its profits from the last 12 months by the number of shares it has given out and is held by stockholders. If the PE ratio of a company’s stock is low, you might be able to buy a valuable stock at a lower price.

In addition to the PE ratio, the market capitalization, or “market cap,” of a company can also help you in figuring out how much a stock is really worth. It can also tell you how profitable a company is. Market cap is computed if you multiply the current share price by the total number of shares held by stockholders.

2. Focus on undervalued sectors.

When looking for undervalued stocks, you could also look at specific parts of the market. For example, if tech stocks are going down, you could look for companies that have gone down with the rest of the sector but still have strong growth potential over the long term.

3. Research.

Use your brokerage firm’s stock screener in narrowing your search and find good opportunities. A stock screener is a tool which makes it so much easier to find stocks that meet certain search criteria. 

Before you buy a stock, think about why you want to buy it. Your “why” will keep you going when the market is volatile. Also, think about following Warren Buffet’s advice to only invest in things you know a lot about.

4. Look into new businesses.

Not all stocks whose prices have gone down are undervalued. They could be from a company in a new or growing industry that isn’t yet popular, so make sure to remember this as you go on with your search. You could also buy only a few shares and wait to see how your investment does over time.

Final Thoughts

Investing in anything has risks, and undervalued stocks are no different. You could put your money into a big company like Tesla and make a lot of money… or not. Some companies with undervalued stock don’t make it, and sometimes investments lose value even more or take longer to do so. 

If you aren’t sure about stock investment, you might want to talk to a financial advisor or stocks expert.