What are Undervalued Stocks?
Author: James Clark
Don’t let short-term factors stop you from investing in a great stock. Learn the advantages and disadvantages of undervalued stocks.
Profits are not only limited to multi-national corporations or conglomerates in the stock market. You can make a fortune by investing in low-priced shares of small and relatively unpopular companies as well. However, before you splash out your cash on any promising publicly traded startup, you should familiarize yourself with both the advantages and disadvantages of undervalued stocks.
Understanding Undervalued Stocks
Undervalued stocks are equity shares with an intrinsic value greater than market value. Stocks can be undervalued due to several reasons, such as:
Rising competition, etc.
For instance, the share of a retail company is selling at $125. However, its intrinsic value is estimated to be $300. Hence, the retail company’s shares are less in value due to volatile market conditions. Stock investors who hunt and invest in undervalued stocks for diversification are referred to as value investors.
Who Should Invest in Undervalued Stocks?
Undervalued stocks potentially offer substantial returns for investors who know how to analyze and trade them. This process requires understanding each company’s earning potential in the long run by understanding its history, financial reports, debt, performance during recessions, and the value of its products and services.
Value investors patiently wait for stock prices to fall below their intrinsic values so they can purchase their shares at discounted prices. This way, they have a chance of earning higher returns when the stock’s market value grows due to favorable economic conditions.
Advantages and Disadvantages of Value Investing
The following are some of the main advantages of value investing:
1. Higher Probability of Profitable Returns
Undervalued stocks prices automatically return to their intrinsic value following an increase in cash flow, meaning profits are assured.
2. Discounted Pricing
Value investors have a chance to buy shares at incredibly lower prices and become shareholders of well-established or promising companies.
3. Lower Risk
Savvy investors are always looking for ways to mitigate or minimize their risk while trading, even when they’re investing in speculative or highly volatile stocks. Undervalued stocks are less risky due to their cyclical nature, meaning the company has the potential to reach its intrinsic value.
4. Anyone Can Invest in Undervalued Stocks
Regardless of your background, income, or wealth, you can invest in undervalued stocks as it simply involves waiting for short-term market fluctuations to grab some shares and benefit from long-term returns.
Below are some of the main disadvantages of value investing:
1. Requires an Investor’s Mindset
While anyone can invest in these stocks, not everyone should because it requires a lot of patience and financial education. Value investors must learn to effectively analyze more information than average traders and look deep for openings.
2. Intrinsic Values are Difficult to Estimate
Perhaps, this is the biggest downside of value investing despite several proven estimation methods. Even when you have all the fundamental information, from past and project revenues to debt and cash flows, this form of trading is still unpredictable due to many intangible factors.
Undervalued stocks can be the most exciting stocks in any portfolio. They could even prove to be the most profitable ones if you play your cards right. However, before you consider investing them, weigh the pros and cons with your trading skills and experience to determine if you can take them on. In the end, value investing is straightforward – buying on bad news and selling on good news.
1. Tupperware Brands Corporation (TUP)
2. Ally Financial Inc. (ALLY)
3. Textainer Group Holdings Limited (TGH)
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