Undervalued stocks are stocks that have the potential to make immense profits.
These stocks may have had a strong market price in the past, but their current price is simply not a reflection of the stock’s true value. Marijuana stocks are a prime example of stocks with a value that is not a true indicator of the company’s worth. Furthermore, historical stock prices are not as vast with newer stocks, such as those seen in this industry.
Before you can begin to analyze a stock, you need to find stocks that have not been valued appropriately.
Formulate a List of Stocks
Formulating your list of stocks to research will depend on your preference. There are plenty of industries that can be researched, but let’s pick marijuana stocks for relevance. Since the industry is still its infancy, it will be difficult to find 20 – 30 stocks to investigate.
Ideally, you will find up to 30 companies that you either: know are undervalued, or are within an industry you are familiar with.
Your stock list can be anything from tech companies to finance. It truly does not matter. The idea is to understand stock market basics by doing research on each and every stock on your list. View this as more of a learning experience the first few times until you really know how to pick great stocks that seemingly do not have an appropriate value.
A few of the technical indicators you’ll want to look at during your preliminary research are:
The P/E ratio is an essential metric that must be fully understood. This ration has two parts:
- P: This is the current price that the stock is currently trading at.
- E: The second letter. This letter signifies the actual earnings per share of the company.
Ideally, the ratio will be as low as possible. If the stock has a 25/1, you’ll be able to realize that this stock price is currently inflated. If the price is lower than the earnings per share, this is a huge indicator of either: a stock that is highly undervalued, or a company that has had some revolutionary bad news occur.
This comes to the ultimate earnings multiplier. Essentially, $100/$10 would have a 10-times earnings.
Remember how we just stated that if the earnings per share is higher than the price there is something amiss? This is determined by the earnings yield. This yield allows an investor to realize that a stock can yield high earnings.
This number would be fraction based; 1/5, 3/5, etc.
You can also find a lot of gems by following Intraday trading trends. These are the trends often followed by short-term traders. If for some reason a stock has tumbled or risen greatly, these trends will be essential in understanding what transpired. Fluctuations often occur because of industry or business changes seen.
With this information, you will be able to narrow your stocks down greatly. Another good indicator is the historical price of the stock. If any major fluctuations occurred that caused the stock to tumble, you may want to dig deeper. Oftentimes, these stocks will rebound greatly and will ultimately be added to your list.
Narrow Your List Down
Now that you have a lot of potential stocks, you will want to narrow them down further. This can be done using the same metrics as above. It is a very tedious process to fully understand and pick out undervalued stocks. In this case, you’ll want to start slowly until you fully understand the process.
Start Examining the Stocks Further
One of the most basic parts of trading is examination. Starting with a small list of stocks will allow you to find stocks with a high potential for profitability. Now that your list is short, hopefully in the range of 3 – 5, you can begin the rest of the process. Don’t worry, you can go back to your list later and examine the rest of the stocks that you have listed.
There are a few things you need to look for. Remember, these are metrics may change depending on your trading style. If you are buying and selling stocks fast, many of these metrics may not be important. If you are in it for the long-term, these are the indicators that you must follow:
- High Profitability: Profitability allows for growth. As a company grows, they should see more profitability and hopefully free cash flow. Many stocks that are seen in new industries, such as marijuana are difficult to judge using this metric. Older companies, however, are always a good choice if high profitability is seen.
- Debt Levels: Again, a metric that becomes more important with age, debt levels should be low. Interest rates can cripple a company when sales are down. A ration of 0.5 is ideal for long-term, debt-to-equity. Current ratios should be above 2.
- Competitive Advantage: One of the most undervalued metrics. You must know about the company and their current operations. This is where marijuana stock values are seen. Patents, trademarks and deals that give a competitor an advantage is essential. These are advantages that cannot be copied with ease, but are essential to the industry or company.
- Business Understanding: This is especially important for new investors. Do you understand the company’s business and really know that this company will excel? It is essential that if you don’t know about the company, you learn about the company and the industry. This is ideal for long-term investments and must be followed.
The four indicators above will show you if the stock’s current value is not what it should be. As an investor, you must also dig deeper and really determine where the company’s future is headed. The few points that I like to examine are:
- The industry as a whole and the projection of the industry.
- Company-related news that shows there is potential in the future.
- The managers and owners of the company.
- Future products or industry news that may indicate that there is a big, positive change in the company’s potential.
If the company has brought in a new manager of operations that is taking control, you will want to know as much as you can about the person. This may seem tedious, but this is the person responsible for the future of the company. If this manager is not competent, you will see the company go on a downward spiral.
Again, the more you know about the company and its internal workings, the better.
You can, and should, follow this process with each and every company on your list. This may take time, but if you’re investing for the long-term, this is simply an essential part of the process that must be followed. You will want to weed out any companies that seemingly do not perform well or that are so far in debt that they are destined to fail.
The Final Assessment
The final assessment will be to determine the intrinsic value of the company and its assets. This can be done in a variety of ways, but you’ll need to find a way that you trust the most. Keeping risks low is essential, and this is what intrinsic value is all about.
You can follow any method you like, but the following methods are most common:
- Price-Earnings Multiplier: Previously discussed. You’ll want to view historic values and calculate a 5 year price through your estimation.
- Return on Equity: Highly utilized in the industry. ROE follows net income divided by shareholder’s equity in the company. This income is a full fiscal year. There are many variations to the return on equity formula discussed that can be utilized. Some account for income minus dividends before dividing by common equity.
The intrinsic value will be what the stock is worth and what its value will be in the future. These numbers are not set in stone (more like a Haze), but they do allow you, as an investor, to lower your risk as much as possible before making an investment.
When finding undervalued stocks, you want to get to know the stock and the company as much as possible. There are no shortcuts that can be taken to find a stock that is seemingly the perfect underdog and has had its value slashed in err.
The newer the stock, the more metrics and indicators you’ll want to use during your assessment. By performing this in-depth analysis, you’ll be able to find stocks that you can depend on in the future.