An undervalued stock’s market value is less than its intrinsic value, making it a good investment. Intrinsic value includes many factors, including a stock’s cash flows, assets, and liabilities. While determining a stock’s intrinsic value can be complicated, the simplest way is to use stock ratios to determine whether it’s a buy. Finding stocks that are both cheap and stable is the best deal. As long as you pay close attention to the market, you might be able to make a fortune from these low-valuation stocks.

Ratios for Valuing Stocks

View stocks on stock trading websites. Good sites include Morningstar or Yahoo Finance. A stock’s profile includes the stock’s current market price, as well as its cash flows, dividends, asset ratios, and other important stock valuation information.

• Most websites will calculate a stock’s price-to-earnings ratio, price-to-book ratio, asset-liability ratio, and current ratio for you.
• You can also find information on the stock’s earnings per share, book value per share, total assets, and total liabilities on these pages.

Look for stocks with lower P/E ratios. The P/E ratio is the ratio of a stock’s current price to its earnings per share. A lower P/E ratio indicates a cheaper stock. Many stock trading websites publish P/E ratios. Of course, you can also calculate it yourself.

• To calculate the P/E ratio yourself, first calculate the earnings per share (EPS) by dividing the company’s total profits from the previous year by the number of shares. Then, divide the current share price by the earnings per share to find the P/E ratio. For example, if a company made $50 million last year and had 5 million shares, its earnings per share would be $10. If the current stock price is $50 and earnings per share are 10, divide 50 by 10. The resulting P/E ratio is 5.
• Generally speaking, invest in stocks with a P/E ratio below 9. Keep in mind that standard P/E ratios can vary by industry. In some industries, the P/E ratio may be higher than in others, but the stock price may still be undervalued.

Look for stocks with a price-to-book ratio of no more than 1. The price-to-book ratio is the ratio between a stock’s current price and its book value per share. Check the book value per share on a company’s balance sheet or stock website. A stock with a ratio below 1 is a low-valuation stock.

• The price-to-book ratio is calculated by dividing a stock’s current price by its book value per share. For example, if a stock’s current price is $60 and its book value per share is $10, its price-to-book ratio is 6.
• The book value of a stock is the price of the stock on the company’s balance sheet. It is based on the company’s assets and liabilities. This information is usually published on the stock page.

Choose companies with a debt-to-asset ratio of 1.10 or below. This means these companies have more assets than debt. This also shows that the company is strong and the stock is good. Stock websites often display gearing ratios on their stock pages. You can also calculate it yourself.

• The gearing ratio is calculated by dividing a company’s total liabilities by its total assets. For example, if a company has total debt of $50,000 and total assets of $100,000, then the debt-to-asset ratio is 0.5.

Pick stocks with a current ratio above 1.5. The current ratio refers to the ratio of a company’s assets to liabilities. 1.5 means the company’s assets are greater than its liabilities. Most stock websites list current ratios on stock balance sheets. It is calculated by dividing a company’s assets by its liabilities.

• For example, if the company has assets of $75,000 and liabilities of $50,000, the current ratio is 1.5.
• Assets are any resources owned by a company that can generate value. Liabilities are any obligations a company has, including debt, that could cause the asset to depreciate in value.

Pick Stable and Profitable Stocks

Choose stocks with an S&P Quality Rating of at least B+. “Standard & Poor’s” is a large financial company that launches a variety of important stock indexes. Their ratings are considered the gold standard in the industry. Quality grades range from D (low-quality stocks) all the way to A+ (high-quality stocks). An A or B+ rating indicates the stock is stable and has upside potential.

• You can view quality ratings on S&P’s website.

Evaluate the company’s cash flow. Stocks of companies with positive cash flow and low stock prices are generally low-valuation stocks. View a company’s cash flow in the Cash Flow section of an online stock profile. Compare current cash flow to previous quarters or years. Look for companies with stable or increasing cash flow. Avoid holding stocks with negative or declining cash flows.

• Cash flow numbers tell you how much money a company actually holds. Positive cash flow may indicate that the stock is more liquid, meaning it is easier to sell.

Check to see if the company is paying a dividend. Dividends are small payments a company makes to shareholders every year. Dividends allow you to make a small profit while waiting for low-valuation stocks to rise. Look for stocks with stable or increasing dividends each year.

• To find out if a stock pays a dividend, look at the stock’s dividend yield. If a company publishes a dividend rate, it means they pay dividends.

Find Low Valuation Stocks

Research a sector of the market to understand which stocks are undervalued. Different industries have different standards. If you focus on 1 or 2 industries, you can start to understand what to expect in that market area. You can more easily identify low-valuation stocks.

• Taking the technology sector as an example, the average P/E ratio of software companies may reach more than 70, while the average P/E ratio of hardware companies may only be between 15 and 20.

Buy stocks during market crashes and corrections. When the market falls, many investors may sell their stocks to cut their losses. Many otherwise profitable companies may have had their shares undervalued during this time.

Check stock value after a bad quarter. If you hear that a company didn’t meet expectations for the quarter, their stock may drop. This could lead to the company’s stock being undervalued for a while. If the company has been stable previously and maintains a good S&P rating, the stock is still a good buy.

• Read financial websites and financial news to learn about trends in certain companies. If a company fails to meet expectations, it may be reported in the news.

Use an online stock screener to find low-valuation stocks. Online tools like Google Stock Screener or Yahoo Stock Screener can set certain stock criteria. You can set your ideal price-to-earnings ratio, price-to-book ratio, current ratio, and other factors. These tools will only display stocks that meet the criteria you set.

• For example, you can set up a filter to search for stocks with a P/E ratio below 20, or you can ask for stocks with a P/B ratio below 5.

Tips

• Some models calculate intrinsic value and low-valuation stocks. However, these models can be very complex. Includes residual income formula and dividend discount model.