How Can You Find Undervalued Stocks in India? Top 5 Indicators Explained

Undervalued stocks are shares that are currently priced lower than their actual worth. These stocks do not reflect a company's true value in the market. Investors make such an assessment using financial indicators like cash flow, profits, and liabilities. Investors look at these indicators to determine if the stock is worth more than its market price.

Furthermore, it must be noted that sometimes, a stock also remains undervalued because the company is small or not well-known. In such a situation, it goes unnoticed by analysts and investors. Even if such a company is growing in sales and profits, its stock price may not immediately increase. In this article, let’s learn 5 indicators that can help you easily identify undervalued stocks.

• Undervalued stocks represent companies that are trading at less than their intrinsic value.
• A low PE ratio shows that a stock is undervalued. For accurate assessment, a comparison of companies within the same industry is done.
• If a company’s stock price is low despite strong and increasing FCF, it suggests the stock may be undervalued.

Investing in undervalued stocks follows Warren Buffett’s famous “value investing” approach. Here, you analyse various indicators and invest in stocks trading below their true value. By doing so, you achieve long-term gains in the stock market. Let’s see the top five indicators following which you can spot undervalued stocks:

1. Price to Earnings ratio (PE ratio)

The PE ratio is a commonly used tool to identify undervalued stocks. It is a ratio of the current market price (CMP) of a company and its earnings per share (EPS). A low PE ratio indicates that the stock is “undervalued” compared to its earnings. This means the market price is lower than it should be.

However, be aware that the PE ratio differs by industry. Therefore, comparing two companies from different sectors, like IT and manufacturing, would not give accurate results. So, while making an assessment, only compare companies within the same industry to judge if a stock is truly undervalued.

2. PEG ratio

The PEG (Price/ Earnings to Growth) ratio goes a step further than the PE ratio. It takes into account a company’s future earnings growth. This ratio compares the PE ratio with the company's projected growth rate. This comparison is more reliable for assessing whether a stock is undervalued or overvalued.

It is worth mentioning that a low PEG ratio suggests that a stock is undervalued and its price does not reflect the increase in earnings the company can achieve in the future.

3. Change in fundamentals

A company has certain core elements, like management or business strategy. When they improve, it doesn't always show up immediately in the stock price. There is often a delay before the market fully acknowledges the positive changes.

For example:

• Say a company hires a new CEO.
• They implement strong growth strategies.
• However, the stock price stays the same for a while before increasing.

In such situations, investors can spot undervalued stocks in the following ways:

• Keep an eye on companies that have recently appointed new and experienced leaders.
• Look for companies that are adopting innovative strategies or expanding into new markets.
• Analyse recent improvements in financial metrics, such as increased revenue, reduced costs, or enhanced profitability.

4. Free Cash Flow (FCF)

Free cash flow (FCF) is a measure of the cash a company generates after covering its operational and capital expenses. It’s a good indicator of financial health, as it shows whether the company can maintain and expand operations. Companies with rising FCFs often use it to pay dividends or buy back shares.

Now, you must note that if a company’s stock is undervalued but has a strong FCF, it can be a signal that the stock price may rise in the future. This makes FCF an important tool for finding undervalued stocks.

5. Price-to-book ratio (P/B ratio)

Sometimes, a company’s stock remains undervalued because its physical assets, like equipment or property, are worth more than the profits from its core business. To assess this, investors look at the P/B ratio and try to get a fuller picture of the company's worth. Usually, a low P/B ratio suggests that the stock is undervalued. This shows that the company has valuable assets that are not reflected in the stock price.