When stock researchers talk about the stock being overvalued or undervalued, they are probably using various stock valuation methods which tries to foretell a stock’s direction. In a simple term, when the stocks are undervalued, they are presumed to go higher and when it comes to overvalued stocks, they are expected to go lower. One thing that is most common in valuation models is that a stock’s price-to-earnings ratio. What does it mean? It means that the ratio for measuring the present share price to the per-share earnings of a company. It is mainly called a P/E ratio or the earnings multiple or the price multiple.
When the undervaluation or overvaluation happens, the value research stocks are compared with the company. Let’s take an example, if a person is selling the stock to a buyer, the investor will contemplate the stock to be overvalued, whereas the buyer will reckon that there is still a lot of capacity in the company so stock rate appreciation will continue. In recent times, there is a huge misconception about Undervalue and Overvalue. Undervalue doesn’t mean that the stock will rise and overvalue doesn’t mean that the stock will correct.
These are just some assumptions! Due to such misunderstanding, few people who are holding the stock are ready to part away with it. An undervalued stock won’t rise instantly, neither the overvalued stock will fall. These days there are no buyers in the stock because nobody wants to consider them. We are going to discuss a few points with you to help you find out how to know if a stock is undervalued or overvalued. The points are listed below:
1. Price-Earnings ratio:
This is one of the main systems the investor uses to determine if a stock is fairly valued or not. The P/E Ratio is calculated by dividing a stock’s price of a company by its trailing 12-month earnings per share. Let’s assume if a stock is dealing for INR 500 and its earnings of the past year are INR 50 then its Price Earnings Ratio will be 10.
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