How to Work Out If a Company Is Undervalued?
There are two main ways to invest in a company -- through stocks or bonds. Stocks represent a form of ownership and stockholders can cash in on the share price appreciation of the asset. Most investors like to buy low and sell high. The challenge with this principle is finding undervalued stocks. One tool or ratio investors use to compare stock value is referred to as the price to earnings or P/E ratio. The measure compares the price of company stock to its earnings.
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Instructions
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Gather your data. You need the current stock price and the earnings per share for the company. You obtain the most recent earnings per share from the company's annual report or by contacting the company's investor relations department. You can obtain the stock price by using your favorite investment research site like Yahoo! Finance, Google Finance or MSN Finance. You can also ask a stockbroker or financial adviser.
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Divide the price of the stock by the most recent earnings per share calculation. Assume the price of the stock is $10 and the earnings per share is $2. The P/E ratio is 5.
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Compare this number against other companies in the same industry. The P/E ratio by itself means nothing, but when compared with other companies in the same industry, you can see if the company is undervalued. Calculate the P/E ratio for at least five other companies in the same industry.
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Interpret the results. In general, a company with a high P/E ratio compared to its peers is overvalued. Likewise, a company with a low P/E ratio is considered undervalued. If the average P/E ratio for competing companies is 8, then the company in this example is considered undervalued at 5.
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