What is an Undervalued Stock?

An undervalued stock is the key to the age-old wisdom of “buy low, sell high,” but most most investors know what that really means.

The definition of an undervalued stock may seem obvious — it’s a stock that is undervalued. This doesn’t necessarily mean these stocks are inexpensive though. As an example, you could buy a brand new Ferrari Roma for $150,000; that would be undervalued, but certainly not inexpensive!

There’s a lot to finding these stocks, though. Value investing, perhaps more than any other type of investing, is more concerned with the fundamentals of a company’s business than its stock price or market factors affecting its price.

Don’t, however, disregard the importance of finding out why a stock is selling at a bargain price. Is the company competing in an industry that is dying? Is the company suffering from a setback caused by an unforeseen problem? The most important question, though, is whether the company’s problem is short-term or long-term and whether management is aware of the problem and taking action to correct it.

Assuming that all checks out, then look at the numbers more closely. Often, an undervalued stock will have strong sales and/or earnings growth, and the market either doesn’t fully understand or appreciate the product yet or has punished the stock for an embarrassing headline that doesn’t truly affect the company’s long-term growth trajectory.

It’s also worth looking at the strategy developed by Benjamin Graham. We used one of Benjamin Graham’s value investing methods for years, with great success.

Mr. Graham suggested that value investors should buy stocks that fit all of the following criteria:

1. The current price-to-earnings (P/E) ratio is 9.0 or less.
2. The price-to-book value (P/BV) ratio is 1.20 or less.
3. The long-term debt-to-current assets ratio is 1.10 or less.
4. The current assets-to-current liabilities ratio is 1.50 or more.
5. Earnings per share growth during the past five years is 1% or more.
6. The company currently pays a dividend.
7. The Standard & Poor’s Quality Rank is B+ or better.

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.