Finding the best investment based on your risk tolerance, time, and specific objectives can be an endless debate, just like multiple investment theories are competing. One of the theories, from 1949 Benjamin Graham’s book, says that an intelligent investor is the one who finds undervalued stocks selling at very low prices than the stock price of their underlying values, due to one or two reasons.
This article will help you learn more about the finding tools, and how to find those undervalued stocks worth investing in.
Tools for Finding Undervalued Stocks
Worried about how you will find the vast undervalued stocks? Say no more. Nowadays, there are several free online tools designed to help investors find and screen undervalued stocks easily and within no time.
To begin with, you can use a stock screener like Ally Invest, our favorite, which provides you with two stock screener types. They are:
– A screener consisting of 6 predefined screens and around 80 choosing criteria.
– Recognia powered technical screener.
Other stock screeners include Yahoo and Google stock screeners. Besides, there are paid online tools like YCharts’ stock screener for more deep search and screening capabilities.
On the other hand, it is advisable to use your brokerage screeners in case you already have an account. Generally, these tools work by analyzing the financial metrics from multiple companies and provide you with those that match your input.
Undervalued Stock Indicators
Generally, there are 6 main criteria to look for:
1. Low price/earnings (P/E) ratio
Generally, all companies have a P/E ratio. The P/E ratio is a very common indicator used for referencing a stock’s relative value and has proved its efficiency.
Usually, a high P/E ratio indicates a high price for the stock relative to the profit, while a low P/E indicates a low stock price relative to the profit, which is the investment opportunity you are looking for. However, it is crucial to find out why the low P/E, as some companies tend to lie about their profit.
2. Lagging relative price performance
This is another ideal indicator to consider. It helps show underperformance situations by screening companies with lower share prices in comparison to other peer industries. Several reasons could result in such situations.
For instance, when stock investors show interest in specific financial metrics, like CNBC, causing a whiplash effect while driving down the price. This situation happens when the investors succeed to drive the price too low to the extent of undervaluing the stock price.
Now, the screener will allow you to compare the histories of an individual stock price for several periods with stock indexes or other individual stocks.
3. Low price/earnings growth (PEG) ratio
The PEG ratio is a ratio of a company’s P/E ratio to its earnings growth rate. It is considered to be more accurate than the P/E ratio only. Usually, when the PEG ratio is below 1, there is a probability that the investors are mostly considering the past performance than the growth opportunities in the future. However, growth projections are just projections.
4. High-Dividend yield
The dividend yield is another way to search for undervalued stocks. When the dividend payment rate of a company exceeds its competitor’s dividend rate, it means that the company’s share price might have fallen under the undervalued situation in comparison to its dividend payment.
Generally, when a company is financially stable, with secured future dividend payments, then this is a good dividend opportunity that can give returns shortly while raising the company’s stock price potential in the future. While using a stock screener to search for a company’s undervalued stocks, then use the “dividend yield %”.
5. Low market-to-book ratio
This is a ratio of the total market capitalization to book value. If an industry has a low market-to-book ratio, then it might be in an undervalued situation. The important factor in this situation is to understand the true value of the tangible and intangible assets of the company.
For instance, the company’s main stock can be undervalued, but on the other hand, the company might be owning very potential assets. Investors look for such companies with potential underlying assets while the main stock is being undervalued. Therefore, it is very important to consider searching and screening for such companies.
6. Free cash flow
Free cash flow is the amount of money made by a company after accounting for all the expenses. This is what investors look for.
Generally, most investors are more interested in the free cash flow of a business than the reported profit. This is because a company’s stock price might be undervalued because of the low reported profit, but on the other hand, the company’s free cash flow might be great deals.
To find such companies using your brokerage firm or stock screener, then find by looking through the cash/share ratio. You will be surprised to find how companies differ in terms of the reported earnings and what the free cash flow can do.
Conclusion
Generally, multiple metrics can be used to determine a good stock value, the above metrics are just some of the best and common indicators. To find a potential undervalued investment, you will have to use several metrics to search and screen. Otherwise, a single indicator can not assure anything, not even an investor. The above article has explained how to easily and quickly find undervalued stocks worth an investment.
