Why is a stock undervalued? • Benzinga


Undervalued stocks exist in the stock market and can be a great opportunity to earn higher returns. Understanding why and knowing how to spot undervalued stocks are keys to capturing those returns. Read on to learn how to capitalize on undervalued stocks and to understand why these mispricings can occur.

Why is a stock undervalued?

A stock can be undervalued for a number of reasons, and it’s not always clear why this happens. Understanding the different scenarios that can lead to stocks being undervalued will help you better identify them.

  1. Poor general market conditions

Poor economic and market conditions can be a common factor in why stocks are undervalued. Deteriorating economic conditions also have an overall negative effect on the stock market.

As economic conditions deteriorate, uncertainty and pessimism increase, making investors more likely to retreat from their current market conditions. When large volumes of shares are sold, it leads to lower share prices. The decline is not necessarily due to the fact that the value of this company decreases, but because of the relationship between volume and stock price. When economic conditions deteriorate, it can be an opportunity for investors to find mispriced and undervalued stocks that they can buy at a discount.

  1. Underdogs

Sometimes a lesser-known company shows strong growth in revenue, sales, and other key financial metrics, but its stock price seems to stagnate. Although fundamentally the company is sound, it may be overlooked by investors because it may be newer, have lower brand recognition, or have yet to be discovered.

For this reason, its stock price remains lower than it should be given the growth demonstrated. Companies like this can be the perfect opportunity for value-oriented investors to buy at a lower price, as the stock price has the ultimate potential to catch up to the actual intrinsic value of the company.

  1. Cyclical companies

Companies in certain industries or with certain business models are cyclical since their sales and revenues occur in a cycle and certain metrics are stronger at certain parts of the cycle. Examples of cyclical industries include luxury goods and airlines. Typically, earnings from cyclical companies will be higher in times of economic growth and prosperity and will suffer in times of economic contraction.

Stocks of cyclical companies may be undervalued due to deteriorating economic conditions rather than a decline in their true intrinsic value. This situation can be good because it presents a buying opportunity for investors who are willing to ride the cycle and wait for stock prices to rise when economic conditions improve. Rather than undervaluing stocks because the company’s value is deteriorating, stocks of cyclical companies will move in line with consumer demand.

  1. bad press

Another common reason a stock becomes undervalued is bad press. When negative reports about a company come out, it can instill fear and pessimistic thoughts in an investor’s head, causing them to sell their position in a company. When enough investors let the bad press get to them and they sell their holdings, it can have a negative impact on stock prices.

Depending on the bad press, stock prices will generally rebound. Poor media coverage generally affects stock prices in the short term and is not an indication of a complete downturn. As an investor, you will need to assess the situation and determine whether you think the company is strong enough to weather the crisis or not. If you believe that the company can overcome the bad news that has been released, it would provide you with an opportunity to invest at a cheaper price.

What is Value Investing?

Value investing is a famous strategy by iconic investor Warren Buffett. This strategy focuses on identifying stocks that are trading at a price below what the intrinsic value indicates they should be traded. By investing in quality stocks that you think the market is undervaluing, they have great potential for growth and strong returns.

This investment strategy focuses on the long term and is more of a passive investment strategy. Value investors rely on financial analysis to determine what a company’s true intrinsic value is to determine whether or not the market is undervaluing that stock.

Should you buy an undervalued stock?

Undervalued stocks have the potential to generate strong returns, given that an investor has properly analyzed the factors that cause that stock to be priced incorrectly. For example, if a stock is undervalued due to bad press or a bad quarter but the intrinsic value of the underlying business indicates that the stock price is undervalued, it could be a good investment to make. On the other hand, if you believe a stock is undervalued due to internal company issues, chances are that stock does not have good growth potential and is not a good investment.

Are undervalued stocks volatile?

Volatility and undervalued stock prices are not clearly correlated. However, often undervalued stocks and highly volatile stocks are associated with companies that investors believe are in trouble.

For example, when a company faces uncertainty about its future, its volatility will likely increase. This happens because investors are unable to fully determine whether or not to invest in this security. In addition, when stocks are undervalued, the market’s perception of a security does not accurately reflect the true book value of that company. This factor may indicate that investors are pessimistic about this company.

Frequently Asked Questions

Is it good if a stock is undervalued?

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Is it good if a stock is undervalued?

asked

Jungyun Kim

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As an investor looking to buy, it can be good for a stock to be undervalued because it allows them to buy at a cheaper price with room for potential growth.

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How do you know if a stock is undervalued?

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How do you know if a stock is undervalued?

asked

Jungyun Kim

1

By finding the intrinsic value of a company and then dividing it by the number of shares outstanding, you will be able to determine the correct price of a stock. If your valuation indicates that the stock price is higher than it is currently trading in the market, that means the stock is undervalued.

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