How to Find Undervalued Growth Stocks

Undervalued growth stocks are a hot commodity and they can be difficult to spot, but if you are good enough at finding them you will do very well. Let's take a look at some tips for finding cheap growth stocks.

Difficulty: Moderately Challenging

Instructions

Things You'll Need:

• Knowledge of valuation ratios
• Understanding of company business plan
• Comparison of value to industry norms

1. The first thing you need to understand is what makes a stock undervalued. There is no clear definition for what makes a stock undervalued, but there are a couple main ways you can look at it. A stock is typically undervalued if its value is lower than others in the industry for no reason. A stock is also usually undervalued if it is cheap from a growth to valuation standpoint.

2. 
   Calculate the PEG ratio

   A good idea for finding undervalued growth stock is to first conduct a price/earnings growth ratio on the stock. The PEG ratio is found by taking the price/earnings ratio and dividing it by the expected growth of the company over the next 5 years. A company is generally considered undervalued if the PEG ratio is below 1. This is a great starting point to finding cheap growth stocks.

3. Take it a step further by comparing the particular stock's PEG ratio or even the basic price/earnings ratio to other companies in the industry. Your goal should be to find a stock that is cheaper than the average company and appears to be financially sound.

4. Another way to find undervalued growth stocks is to look at how much the market typically pays for the stock and look to buy at times that the stock is trading below that valuation. For example, if the stock has generally traded for 15 times earnings, but right now it trades at only 10, it might be worth a closer look.

5. 
   Are growth stocks out of favor?

   When will you find more undervalued growth stocks? Undervalued growth stocks tend to be abundant when growth stocks go out of favor on Wall Street. Growth stocks are typically out of favor when the economy is slowing down or when the Federal Reserve is raising interest rates aggressively. If you can pick and choose one of the best growth stocks during this period you will do well in the long run.

6. As an investor you need to be able to understand that these kind of undervalued growth stocks are typically fairly risky, but they also come with great rewards. Understand that with a decent amount of risk you have the potential for some pretty nice rewards.

Tips & Warnings

• You'll need to be patient to find the best growth stocks at a great price. It doesn't happen too often.
• Sometimes classic growth stocks are undervalued because something has substantially changed at the company. Be careful to do thorough research on what is going on at the company before considering it a cheap growth stock.

[Diablo2]

on 10/14/2009 You obviously know what you're talking about. 5 stars.