How do you check if a stock is overvalued or undervalued?
The sales per share metric is calculated by dividing a company's 12-month sales by the number of outstanding shares. A low P/S ratio in comparison to peers could suggest some undervaluation. A high P/S ratio would suggest overvaluation.
Price-earnings ratio (P/E)
A high P/E ratio could mean the stocks are overvalued. Therefore, it could be useful to compare competitor companies' P/E ratios to find out if the stocks you're looking to trade are overvalued. P/E ratio is calculated by dividing the market value per share by the earnings per share (EPS).
A critical aspect of CAPM is the concept of undervalued and overvalued securities. If the rate of return is greater than the expected return, it would be considered an overvalued security. If the rate of return is less than expected returns, it would be regarded as undervalued security.
Price-to-earnings ratio (P/E ratio): A company's stock price divided by its EPS. This ratio helps investors assess whether a stock is overvalued or undervalued relative to its earnings.
P/E ratio = P/E ratio / Growth rate of the company's EPS. Dividend-adjusted PEG Ratio / (Growth rate of EPS + Dividend paid). Financial experts consider a PEG ratio below 2 to be the threshold; above this, such stock is considered overvalued. Hence, the lower the PEG's value, the more undervalued it is and vice versa.
A company is considered overvalued if it trades at a rate that is unjustifiably and significantly in excess of its peers. Overvalued stocks are sought by investors looking to short positions and capitalize on anticipated price declines.
Undervalued Stock vs Overvalued Stock
The main point of difference is the variation between the intrinsic value and the share price. When the intrinsic value is more, the share is undervalued; when the share price is high, the share is overvalued.
An overvalued asset is an investment that trades for more than its intrinsic value. For example, if a company with an intrinsic value of $7 per share trades at a market value $13 per share, it is considered overvalued.
You generally use the P/E ratio by comparing it to other P/E ratios of companies in the same industry or to past P/E ratios of the same company. If you are comparing same-sector companies, the one with the lower P/E may be undervalued.
- Avenue Supermarts Ltd. Retail - Department Stores.
- Coal India Ltd. Mining - Coal.
- Varun Beverages Ltd. Soft Drinks.
- Eicher Motors Ltd. Trucks & Buses.
- Oil India Ltd. Upstream Oil & Gas.
- Colgate-Palmolive (India) Ltd. Consumer Goods.
- Abbott India Ltd. Pharmaceuticals.
- CRISIL Ltd. Credit Rating.
What makes a stock undervalued?
An undervalued stock is defined as a stock that is selling at a price significantly below what is assumed to be its intrinsic value. For example, if a stock is selling for $50, but it is worth $100 based on predictable future cash flows, then it is an undervalued stock.
Low valuation ratios. One of the quickest ways to gauge whether a stock is undervalued is to compare its valuation ratios to the rest of its industry or the overall market. If the ratios are below that of the industry average or a broad market index such as the S&P 500, you may have a bargain on your hands.
High price-to-earnings (P/E) Ratio: A stock with a P/E ratio significantly higher than its industry peers or historical average may be overvalued. Price-to-earnings growth (PEG) Ratio: An elevated PEG ratio, especially above 1, can indicate an overvalued stock.
Typically, the average P/E ratio is around 20 to 25. Anything below that would be considered a good price-to-earnings ratio, whereas anything above that would be a worse P/E ratio. But it doesn't stop there, as different industries can have different average P/E ratios.
With its 2-star rating, we believe Apple's stock is overvalued compared with our long-term fair value estimate of $160 per share. Our valuation implies a fiscal 2024 adjusted price/earnings multiple of 25 times, a fiscal 2024 enterprise value/sales multiple of 7 times, and a fiscal 2024 free cash flow yield of 4%.
Amazon's performance remains strong, with robust earnings and reasonable valuation metrics suggesting the stock is not overvalued.
A high RSI, generally above 70, signals traders that a stock may be overbought and that the market should correct with downward pressure in the near term. Many traders use pricing channels like Bollinger Bands to confirm the signal that the RSI generates.
S.No. | Name | P/E |
---|---|---|
1. | Coal India | 9.23 |
2. | Bajaj Auto | 34.54 |
3. | Sun Pharma.Inds. | 41.90 |
4. | Zydus Lifesci. | 30.87 |
In general, if the company's current P/E is at the lower end of its historical P/E range or below the average P/E of similar companies, it may be a sign that the stock is undervalued—regardless of recent business performance.
By the same token, though, holding on to a company that is overvalued is a risk. In these situations, it's typically best to sell your stock and be happy with the profits you've made no matter what the stock does in the future.
What are the most overvalued stocks right now?
Symbol | RSI (14) | Price |
---|---|---|
LABP D | 95.58 | 21.49 USD |
VVPR D | 93.99 | 6.41 USD |
ALCC D | 92.61 | 12.87 USD |
ABIO D | 92.56 | 3.25 USD |
Thus the percentages on the vertical axis show the over/undervaluation as a percent above mean value, which we're using as a surrogate for fair value. Based on the latest S&P 500 monthly data, the market is overvalued somewhere in the range of 89% to 149%, depending on the indicator, up from last month's 82% to 140%.
A high P/E might indicate that investors expect earnings growth in the coming quarters and, as a result, investors have been buying the stock in anticipation of its appreciation. A negative P/E ratio means the company has negative earnings or is losing money.
S.No. | Company | Industry/Sector |
---|---|---|
1. | Tata Consultancy Services Ltd | IT - Software |
2. | Infosys Ltd | IT - Software |
3. | Hindustan Unilever Ltd | FMCG |
4. | Reliance Industries Ltd | Refineries |
Fair value is the sale price agreed upon by a willing buyer and seller. The fair value of a stock is determined by the market where the stock is traded. Fair value also represents the value of a company's assets and liabilities when a subsidiary company's financial statements are consolidated with a parent company.