What is an Undervalued Stock?

There are plenty of cheap stocks out there. And you can find an undervalued stock or two, as well. But rarely are they the same thing. 

An undervalued stock is one with a strong balance sheet, good earnings growth, and a low price-to-earnings ratio (P/E). You can often find these stocks by looking for those that are beaten down by the market due to bad news or negative rumors. Benjamin Graham, the father of value investing, constantly searched for companies that once fetched sky-high valuations but that crashed when the companies were unable to deliver on investors’ expectations.

Be aware, however, that undervalued and cheap are two very different things. A cheap stock can very easily get cheaper, meaning you’re losing money. An undervalued stock, on the other hand, will likely increase in price over time. 

To profit with these stocks, look for companies that are currently paying dividends. Investing in undervalued companies requires waiting for other investors to discover the bargains you have already found. Sometimes your wait period will be long and tedious, but if the company pays a decent dividend, you can sit back and collect dividends while you wait patiently for your stock to go from undervalued to overvalued.

It’s also important to look closely to determine why an undervalued stock is priced the way it is. Is the company dealing with a short-term or long-term problem and is management aware of it and taking action to correct it? 

Study the sales, too. If a company’s sales are increasing every year, even when the economy is weak, we’re interested in the potential of its stock. Don’t mistake profits for increasing sales, though. Many companies are cutting costs, and that is one way to increase profits, but if their sales aren’t growing, their future growth is jeopardized. What the companies are doing is downsizing the company, which will lead to stock price erosion sooner rather than later.

To learn more and discover how you can find the right stocks for your portfolio, download our free report, How to Find Undervalued Stocks – Plus the Benjamin Graham Approach to Value Stocks, right now.