Definition and Examples of Undervalued Stock
An undervalued stock is one that appears to be trading at a lower price than its fair value, which some investors may perceive. Undervalued stocks are considered part of a value investing strategy, although it is possible for some investors to view certain growth stocks as undervalued at times. Let’s take a closer look at what an undervalued stock means.
How Undervalued Stock Works
An undervalued stock occurs when investors believe that the stock price of a company is lower than it should be. One reason this might happen is if the company is caught up in a broader market sell-off. Bad news within the banking industry might cause a significant sell-off of stocks. However, this news may only affect certain banks, yet the stock prices of other financial institutions that are less impacted by the news still decline sharply. In this case, other investors might see some of these unaffected stocks as undervalued.
Another reason a stock might be considered undervalued is if demand for stocks has shifted to other areas, such as if a particular sector becomes trendy, driving prices up. At the same time, limited demand for stocks in another sector may place pressure on the stock price growth, even if the financial fundamentals of these companies remain strong.
In many cases, investors consider undervalued stocks to be mature companies, so there may not be much excitement and faith in their long-term growth potential.
A manufacturing company that has been around for decades and continues to earn profits at a reliable pace may be seen as such. However, this may not attract as much interest from investors as a startup with massive revenue potential, causing investors to buy at a much higher P/E ratio. At the same time, the stock price of the manufacturer may become undervalued if there is not much interest in it, even if some developments within the company are increasing its value.
What Undervalued Stock Means for Individuals
Understanding what undervalued stocks are can help individuals make better investment decisions.
Although undervalued stocks are perceived to be worth less by some investors, there is no guarantee that what some investors believe to be undervalued will be viewed that way by others. The stock price may not rise to what some investors deem its fair value, so not every investment in undervalued stocks is a slam dunk.
An undervalued stock occurs when investors believe that the stock price of a company is lower than it should be. One reason this might happen is if the company is caught up in a broader market sell-off. Bad news within the banking industry might cause a significant sell-off of stocks. However, this news may only affect certain banks, yet the stock prices of other financial institutions that are less impacted by the news still decline sharply. In this case, other investors might see some of these unaffected stocks as undervalued.
Reason
The last that may consider the stock undervalued is that demand for stocks may have shifted to other areas, such as if a certain sector became popular, driving prices up. At the same time, limited demand for stocks in another sector may put pressure on the stock price growth, even if the financial fundamentals of those companies remain strong.
In many cases, investors consider undervalued stocks to be mature companies, so there may not be much excitement or faith in their long-term growth opportunities.
A manufacturing company that has been around for decades and continues to generate profits at a steady pace may be seen as reliable. However, this may not attract as much interest from investors as a startup with massive revenue potential, which may lead investors to buy at a much higher P/E ratio. At the same time, the share price of the manufacturing company may be undervalued if there isn’t much interest in it, even if some developments within the company increase its value.
Key Takeaways
Stocks considered undervalued are regarded as below their price by some investors. Undervalued stocks are commonly associated with value investing strategies, but it’s also possible for some growth stocks to sometimes be considered undervalued. There is not necessarily one fair value, so some investors may consider certain stocks undervalued, while others may not see them that way.
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Sources:
E-Trade. “Growth vs. Value Investing.”
Source: https://www.thebalancemoney.com/what-is-an-undervalued-stock-5225895
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