How To Find Undervalued Stocks in 2024 (Step by Step Guide)

Ruby Layram 30th May 2024 No Comments

Reading Time: 5 minutes

Investing in undervalued stocks is a common strategy used by investors to pocket capital gains. The idea is that undervalued stocks have more room for growth – which means more room for returns!

Finding these stocks is like finding hidden treasure. They aren’t always obvious and take some digging to find. In this guide, I will explain how to find undervalued stocks in 6 steps.

• What are undervalued stocks?
• Why might undervalued stocks be a good investment?
• 6 steps to find undervalued stocks in 2024

What Are Undervalued Stocks?

An undervalued stock is exactly what it sounds like. It is a stock that has a value less than its true worth.

These stocks are believed to be priced too low and therefore, it is likely that their value will go up at some point in the future.

You can find undervalued stocks in all industries of the market. However, these stocks are most common in industries that are undervalued themselves.

Deciding whether or not a stock is undervalued is a key part of fundamental analysis. It indicates whether or not a stock has the potential to go up in price.

Investors use a range of indicators to decide whether a stock is undervalued. We will take a look at these later! 

The easiest way to understand these stocks is to think about finding bargains on eBay. For example, you might find a handbag that is being sold for £50 but has a true value of £250. You know that if you buy the handbag, you could make money by selling it for a higher price at some point in the future.

The same goes for undervalued stocks. Except, they are much less fashionable!

Investing in undervalued stocks is sometimes known as ‘value investing’. It is a strategy most famously used by Warren Buffet.

Why Might Undervalued Stocks Be a Good Investment?

So, why might some investors want to buy undervalued stocks?

The answer to this is simple. The more undervalued a stock is considered to be, the more room it has to grow. So by investing in undervalued stocks, investors increase their chances of seeing returns.

On the flip side, overvalued stocks have the potential to go down. So investors tend to avoid these.

The potential for returns is not the only reason that you might want to consider adding undervalued stocks to your investment portfolio.

Low Barrier to Entry

Investing in undervalued stocks is a cheap way to expose yourself to companies that have big potential. Imagine if you could have bought shares of Apple for $22 in 1980!

Low-priced stocks are suitable for investors who want to build a diverse portfolio without putting too much capital at risk.

Room for Growth

Generally speaking, undervalued stocks have more growth potential than stocks that are priced correctly or even overvalued.

So, by investing in undervalued stocks, you are more likely to see significant gains.

However, it is important to understand that there is NEVER any guarantee that the value of a stock will go up.

6 Steps to Find Undervalued Stocks in 2024

Value investing could be a good strategy to consider if you know your stuff about the stock market!

So, how exactly do you find stocks that are undervalued?

Here’s how to find undervalued stocks in 9 steps. 

Step 1: Look at Ratios

It turns out Maths GCSE is useful in real life (who would have thought!).

One of the first steps that you should take to find undervalued stocks is to look at a company’s ratios. These are numbers that paint a picture of a company’s financial health.

Understanding ratios is quite complex and it’s worth spending time familiarising yourself with the numbers before you start your research.

Here are some key ratios to look out for:

• Low price-to-earnings (P/E) ratio
• High return on equity (ROE)
• Earnings yield higher than the average US interest rate
• Low price-to-earnings to-growth ratio (PEG)
• Price-to-book ratio lower than 1

Step 2: Look for Consistent Dividend Yields

Consistent dividend payments are a sign that a company’s financial health is strong. This is particularly the case if a company has a history of paying high yields consistently, even if the share price is low.

When it comes to analysing dividend stocks, consistency trumps a generous yield.

Step 3: Look At the Competition

Another way to determine if a stock is potentially undervalued is to check out the competition.

Find other companies that offer very similar services and compare the prices of stocks. If the price of another company’s shares is significantly higher, this could be a sign that a stock is undervalued.

However, always remember that there is a chance that other stocks are overvalued.

Step 4: Dive Into Financials

This is where the real detective work begins!

Analysing a company’s financial statements can help you to get a bigger picture of the stock and the financial health of the company.

Key areas to look at include:

• The balance sheet
• Income statements
• Earnings reports

Again, it is worth familiarising yourself with these documents before starting your research.

Generally speaking, if a company reports consistent positive earnings and minimal debt, but hasn’t seen its share price go up, it could be undervalued. 

Step 5: Focus on Undervalued Sectors

If you’re looking for an undervalued stock, it is wise to start your search in an undervalued sector.

It is normal for sectors to experience a decline in stock prices every now and then. These declining sectors present an opportunity to invest in a declining stock that will do well when the industry eventually recovers.

Step 6: Use a Robo Advisor

Robo advisors and AI investing apps are clever investment platforms that do the research for you!

Using a robo advisor could be a good way to research undervalued stocks without having to become a financial expert yourself.

However, robo advisors aren’t always accurate and it is important to conduct your own analysis alongside the AI tool.

Value investing by finding undervalued stocks is a popular investment strategy that could be used to build a diverse portfolio. But remember, there is no guarantee that the price of any stock will go up – even if it seems really undervalued.

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Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence. When investing your capital is at risk.