UK Accounting Glossary
A stock is undervalued when, based on fundamentals like earnings and growth prospects, it should be selling at a higher price than it is. Whether or not a stock is undervalued, however, is always an opinion – one analyst’s undervalued stock is another analyst’s sell recommendation. Indeed, some would say there is no such thing as an undervalued (or overvalued) stock, because the price of a stock is, by definition, what it’s worth. Many investors argue, however, that the market may temporarily price stocks too high or too low, and it is possible to find undervalued stocks. Investors use various indicators to determine whether a stock is undervalued. Perhaps the best-known measure for finding an undervalued stock is the price-earnings ratio (P/E). Consider Acme and Universal, which are in the same industry and have similar fundamentals. If Acme has a P/E of 15 and Universal’s is 20, then Acme could be an undervalued stock. Finding undervalued stocks is rarely that simple, however, and investors must often do considerable research to find equities that are truly undervalued.
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This glossary post was last updated: 5th February 2020.