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What exactly are undervalued stocks? By definition, an undervalued stock is one that is being sold significantly below its assumed intrinsic value. Intrinsic value is a financial term that can be calculated by adding up an asset’s future income discounted by its current value.
An example of an undervalued stock would be one that is selling for $25 but can be figured out to be worth approximately $50 based upon what would be projected and predicted cash flow in the future. There are many books available in the marketplace explaining undervalued stocks.
The first area to review as a potential investor would be a ratio known as the price to earnings ratio. You also should investigate the management of the company behind the stock as well as the nature of business. As indicated in Warren Buffett’s 1989 letter to Berkshire Hathaway shareholders, “a value of a business is the sum of the cash flow over the life of the business discounted at an appropriate interest rate.” Warren Buffett, by the way, is commonly known as “The Oracle of Omaha.”
Therefore, as a potential future investor, you need to feel confident that a company’s stock may be undervalued based upon the future earnings as well as future interest rates. Some other examples would be:
- What is the company’s history? And is it a stable consistent operating company?
- The company does specialize in an industry that may fizzle in a short period of time.
- The tangible (hard) asset value is not lower that the company’s selling price.
- The company has a credit rating of a triple A, double A or an A.
- During the last recession, the company did not experience a loss.
According to Buffett’s partner, Charles Munger, a good rule of thumb is the purchase price of an excellent stock at a fair price is more likely to be undervalued than a poor stock at a cheap price.
If you are a newcomer in the stock market, be sure not to invest more than you are willing to lose. There are many stocks that could be classified as undervalued. Some are what is referred to as penny stocks. You need proceed with caution however, and do your research prior to investing. You may be lucky and find undervalued stocks that really take off whereby you make a huge profit. On the other hand, you can also lose your life savings. Get information and be informed. The information is available online, at the library or by seeking out a stock professional.
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