Undervalued Stocks 

Buying stock is a great and mind-provoking exercise when you find stocks at levels less than their intrinsic values. In fact, such is the case with undervalued stocks. Such often go unnoticed by the overall market, and it offers an opportunity to intelligent investors to earn significant profits. This article is a complete package of the complete knowledge base on undervalued stocks, traits, advantages, disadvantages, and practical examples, in simple terms for readers at entry level. 

What is Undervalued Stocks? 

Undervalued stocks refer to the share of a company that is currently trading at a lower price compared to its intrinsic value. Intrinsic value is considered to be the true value of a stock, usually estimated by a number of fundamental metrics about the firm, such as earnings, dividends, cash flow, and growth prospects. In simple words, they are “underpriced” compared with their actual value, giving investors a good chance of making money as the market corrects that mispricing. 

For instance, if the quoted stock of the company is US$50 per share, but the intrinsic value was calculated as US$80, then it indicates that the company is undervalued. The crucial difference between the market price and intrinsic value often takes place in the cases of market imperfections, external economic changes, or short-term unfavorable attitude towards the company. 

Value investing is the philosophy that was popularised by legendary investors like Benjamin Graham and Warren Buffett, who emphasise that undervalued stocks should be invested in. According to value investors, buying undervalued stocks and holding them until the market recognises their true worth can bring great returns. 

Understanding Undervalued Stocks 

Now, to really understand undervalued stocks, one must understand the reasons stocks might trade below intrinsic values: 

1. Inefficiencies of the Marketplace: The stock market cannot be rational all the time. Sometimes investors overreact with respect to short-term news and the price of an equity falls when its basics are sound.

2. Negative Sentiment: Poor quarter, management controversies, and even sector-wide challenges can make stocks appear undervalued as their long-term prospects have not changed.

3. Economic Cycles: It may be that the market experiences an economic downturn or a recession, which pushes sector-wide selling, allowing fundamentally strong companies to go for a discounted price.

4. Misunderstood Business Models: Some companies become undervalued because its business model is complex, not understood by the ordinary investor.

Investors often use financial analysis and a variety of valuation metrics to determine whether a stock is undervalued. Using such tools with good judgment helps find attractive investment opportunities. 

Characteristics of Undervalued Stocks 

There are a few common characteristics of undervalued stocks that separate them from overvalued or fairly valued stocks. These common characteristics help investors find their hidden gem. 

1. Low P/E (Price-to-Earnings) Ratio

This would then mean the comparison of the price of a firm’s stocks to earnings per share, or EPS. If its P/E ratio is quite low, especially relative to peers in the same industry, then it would signify an undervalued stock. 

For example, if the average P/E ratio in a sector is 20 and a company in that sector has a P/E of 12, then it may be worth investigating why it is trading at a discount. 

2. Strong Financial Fundamentals

Undervalued stocks typically represent financially sound companies. 

Some of the most important indicators of good fundamentals include: 

• Revenue growth over time. 

• Positive cash flow, which would state whether the organisation is bringing income. 

• Manageable debt levels, which maintain that the company is neither overleveraged. 

3. High dividend yields

A dividend yield above the firm’s past average or industry peer group could mean that the firm is undervalued. Dividend paying stocks are more stable in general. So, high yield may represent depressed stock prices. 

4. Sector Factors

Sometimes, out-of-favour sectors, like the energy sector during low oil prices, can present firms that are otherwise healthy but may be undervalued. Their turn comes when the economy cycles back to normal. 

5. Bearish Market Sentiment

Market sentiment often works quite negatively on stock prices. Here, the undervalued stock would be one that was wrongly punished due to investor pessimism, although its fundamentals were good. 

Benefits and Risks of Investing in Undervalued Stocks 

Benefits of Investment in Undervalued Stocks 

1. High Return Chance

Investing in undervalued stocks has the chance of yielding high returns when the market finally recognises their real worth. 

2. Low Chances of Loss

Since undervalued stocks are already sold at a discount, they are less likely to fall than overvalued stocks. 

3. Income through Dividends

Most of the most underappreciated stocks are mature companies that pay dividends regularly, therefore giving an investor a steady flow of income. 

4. Portfolio Diversification

Adding undervalued stocks in a portfolio reduces its risk, especially if those undervalued stocks are diversified across different industries or geographies. 

Risks Associated with Investing in Undervalued Stocks 

1. Lengthy Periods of Undervaluation

Not all undervalued stocks become overvalued again quickly. Some may stay undervalued for a long time as the market doesn’t get it or there is a sectoral problem. 

2. Fundamental Flaws

Sometimes, a stock has good reasons for being undervalued—revenue starts falling, more competition develops, or poor managerial decisions are made. 

3. Market Volatility

Although an undervalued stock may suffer temporary short-term losses due to broader market fluctuations, investors have to foresee such volatility. 

4. Error in Estimation of Intrinsic Value

This value cannot be calculated. Investors can overestimate a stock’s value and, hence, be disappointed by returns. 

Examples of Undervalued Stocks 

Let’s see some practical examples of undervalued stocks from the US and Singapore markets. 

US Market Examples 

1. Bristol-Myers Squibb (NYSE: BMY)

Overview: A global biopharmaceutical leader, Bristol-Myers Squibb focuses on innovative medicines for serious diseases. 

Valuation Insight: The company with a drug pipeline and consistency trades at a lower P/E ratio than the peers, hinting that it is slightly undervalued. 

Investment Attraction: The company gives a moderate level of dividend and promises growth prospects. Therefore, this can be a good bargain for the value investor. 

2. Entergy Corporation (NYSE: ETR)

Entergy Corporation Overview: A leading utility company involved in electricity generation and distribution. 

Valuation Insight: Trading at a discount at the moment due to market concern over regulatory change despite the investment in renewable energy and stable cash flows. 

Investment Attractiveness: Its defensive nature and essential products are attractive during uncertain economic conditions. 

Singapore Market Examples 

1. Singapore Technologies Engineering Ltd. (SGX: S63)

Background: A diversified engineering company with defense, urban solutions, and aero-space businesses. 

Valuation Insight: The company enjoys a huge discount to its intrinsic value and has further growth potential as global spending on infrastructure increases. 

Investment Attractiveness: The Company’s diversified revenue streams provide stability and long-term growth. 

2. Hongkong Land Holdings Limited (SGX: H78)

Overview: A property investment and development company with a robust portfolio in Asia. 

Valuation Insight: Trading at below its asset value because of the pessimism of the market regarding the Hong Kong real estate sector. 

Investment Attractiveness: Quality assets and a strong balance sheet make it high on the potential for recovery. 

Frequently Asked Questions