Undervalued securities have a market price that is significantly lower than their fair value (market value < fair value) as a result of decreasing investor confidence or consensus estimates. Financial analysts use the price to earnings ratio (P/E) or calculate the growth rate of a firm to determine if a stock is undervalued. Stocks are deemed as undervalued either following a decline in demand driven by declining investor confidence or if the firm’s fundamentals improve rapidly while the market price remains constant. In both cases, if the company’s fundamentals and the analyst growth projections do not justify a decline in the market price, the stock is possibly undervalued.
In a nutshell :
- An asset that is undervalued is one that has a market price less than its perceived intrinsic value.
- Buying undervalued stock in order to take advantage of the gap between intrinsic and market value is known as value investing.
- For a stock to be undervalued means that the market price is somehow “wrong” and that the investor either has information not available to the rest of the market or is making a purely subjective, contrarian evaluation.