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Investing in the stock market requires investors to carefully assess and identify the stocks that have a strong return potential. This also requires one to pick stocks that are undervalued in the current market conditions, presenting a potential investment opportunity. In this article, we cover what undervalued stocks are, key metrics to identify them, and how to invest in one.
Stocks that are priced lower than their intrinsic value based on financial metrics and fundamentals are considered as undervalued stocks. These stocks may offer a potential buying opportunity for investors. For example, if Company A’s stock is trading at INR 1,000, while analysts estimate its intrinsic value to be INR 2,000, this suggests potential for growth if the market conditions improve.
A stock can become undervalued based on temporary market overreactions to bad news, fear-driven selling, or neglect by investors. Some of the key reasons for a stock to become undervalued are:
Investors use some key financial ratios to find undervalued stocks where the market price lags intrinsic value. The key metrics are as follows:
Once you have identified the undervalued stocks, you can start investing in them. Here are the following steps to invest in undervalued stocks.
Step 1: Sort the list of undervalued stocks you have planned to invest in, based on the key metrics.
Step 2: Check balance sheets for positive free cash flow, stable earnings growth, and a strong current ratio (>1.5). Look for any changes, such as new management, industry recovery, or mergers and acquisitions, before investing.
Step 3: Allocate some of your funds (5 to 10%) per stock, hold long-term as the market corrects pricing.
If you hold a premium savings account with DBS Treasures, you can take advantage of sophisticated wealth solutions and timely market insights, helping you to make well-informed decisions for investments.
Growth stocks are often priced as a premium for rapid expansion potential, whereas undervalued stocks trade below their intrinsic value. Some of the key differences between undervalued stocks and growth stocks are:
Aspect
Undervalued (Value) Stocks
Growth Stocks
Pricing
Low P/E, P/B ratios (< industry avg)
High P/E, P/B due to future hype
Growth Rate
Stable, mature earnings
High revenue/EPS growth (>20% YoY)
Dividends
Often pay steady yields
Reinvest profits, low/no dividends
Risk Profile
Higher if value trap; recession-resilient
Volatile, bull market winners
Strategy
Buy low, wait for correction
Buy momentum, sell at peak
Often, investors can make mistakes in choosing a seemingly “undervalued’ stock expecting positive returns. Mistakes like these can lead to loss of investment. Some of the common mistakes when buying undervalued stocks:
Undervalued stocks offer investors the opportunity to earn significant returns. Investors should use the right metrics to assess and identify these stocks. Investors have to hold these stocks for the long term to see favourable returns. Investors planning to invest in undervalued stocks can also consider creating a wealth account with DBS Treasures, guiding you towards achieving your financial goals with services such as day-to-day banking, investment, and more.
Disclaimer: The information provided in this article is for general informational purposes only. For specific guidance or details, please consult with your Relationship Manager or a relevant expert.
