What is Undervalued / Overvalued?

by Investing School on April 20, 2011

The term “undervalued” or, on the opposite hand, “overvalued” makes reference to a stock currently selling at a price well below or above its assumed actual value. As an example, if a stock is being sold at $25, but should be worth $50 according to predicted cash flow in the future, then the stock is undervalued. On the other hand, a stock that is currently selling for more than its true value displays the opposite scenario, and that stock is overvalued. One of the keys to making money with investments is to select stock from companies that are currently undervalued, so that as the value of those securities increases while you hold them you experience a profit!

Obviously, an investor needs to be quite sure that a business is going to be profitable in the future in order act on it as an undervalued security. Companies with undervalued stocks may have some of the following traits: a stable earning history, no financial scandals in their recent history, a good credit rating (meaning one of AAA, AA, or A stocks), a selling price that is below its tangible asset value, increasing trailing three year earnings over the past decade, not posting a loss during the most recent recession, and other considerations.

Some of the best advice for finding undervalued and avoiding overvalued stocks may be to remember that a good stock at a fair price is probably more likely to be undervalued than a bad stock at a cheap price. This is good indicator because good stocks continue to rise over the long term, while bad stocks tend to drop.

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