Definition of Undervalued Stocks
In the financial market, a stock is the capital that a company raises by selling shares of interest in the company. Investors buy and sell stock on the stock market to make money. The goal is to buy low and sell high, which is best done using ‘undervalued’ stocks.
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Identification
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An undervalued stock is a stock that is selling at less than its potential value. Investors use stock valuation to determine the potential value of the stock. This is done using predictions of a company’s future cash flow and profitability.
Undervalued Stock Characteristics
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Some characteristics of a stock that may be undervalued are that the company has an earnings growth rate that is higher than market average, a stable earning history and a historically consistent Return on Equity (ROE). They should also not specialize in something that can quickly become obsolete.
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Significance
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Buying undervalued stocks allows an investor to make a great deal of money down the road. When a stock is bought at less than its potential value, the buyer can eventually sell it for much more than he paid. The final piece of the puzzle is selling it at the right time.
Time Frame
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No one knows when an undervalued stock will rise or how long it will continue to rise. It may take years to reach its full value, or an owner may see an early rise and sell too early to realize most of its value. When you buy an undervalued stock, you should be prepared to hold on to it for as long as necessary.
Warning
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Not all ‘undervalued stocks’ are really undervalued. Some may be actually be overvalued, but the investor does not realize this until it is too late and the stock falls quickly. This happened with many ‘undervalued’ stocks when the dot-com financial bubble busted and many companies went out of business.
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References
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