The stock market isn’t always rational.
Prices swing based on emotions, macroeconomic events, and investor sentiment, which can create opportunities for investors to buy stocks when they’re undervalued.
In this article, we’ll talk about how to find undervalued stocks by first exploring what factors typically lead to stocks becoming undervalued, some of the best strategies to find undervalued stocks, and how to determine if a stock is undervalued.
Factors That Lead to a Stock Being Undervalued
Stocks typically become undervalued for a few key reasons.
Investors can keep an eye out when they see these factors because they might find opportunities to buy great stocks when they’re undervalued:
Macroeconomic Conditions
Rising interest rates, inflation, or geopolitical risks can lead to broad market sell-offs that push even strong companies into undervalued territory.
Example: In March 2020, the COVID-19 pandemic caused a massive market crash, with stocks like Microsoft (MSFT) and Visa (V) dropping over 30% despite their strong business models. Many high-quality stocks became temporarily undervalued due to panic selling, only to quickly rebound once the economy stabilized.
Short-term Market Overreactions
Stocks often fall too far on temporary bad news, which can create buying opportunities.
Example: In 2018, Facebook (now Meta, $META) saw its stock drop over 40% following the Cambridge Analytica scandal and regulatory concerns over data privacy. Despite the panic-driven sell-off, Meta continued to grow its advertising revenue and user base, which led to a strong stock recovery in the following years.
Earnings Misses or Negative Headlines
A single bad quarter doesn’t define a business, yet the market often reacts harshly to poor earnings performance.
Example: In 2019, Starbucks (SBUX) stock dropped over 10% in a single day after reporting weaker-than-expected same-store sales growth in China. Investors feared slowing international expansion and increasing competition from Luckin Coffee would hurt Starbucks’s long-term growth.
However, Starbucks continued to expand, leveraged its strong brand, and recovered as sales rebounded. By 2021, the stock had nearly doubled from its 2019 lows, proving that short-term earnings misses don’t always indicate long-term problems.
Underappreciated Growth Potential
Sometimes, the market underestimates a company’s long-term growth prospects.
Example: In 2014–2015, Amazon (AMZN) was trading at a historically low P/E ratio as investors worried about thin profit margins and heavy spending on fulfillment centers and AWS (Amazon Web Services). Many believed the company was sacrificing profitability for growth.
However, Amazon’s investment in cloud computing became a massive earnings driver, turning AWS into a high-margin business that fueled long-term stock appreciation.
Cyclical Downturns in an Industry
When an entire sector is out of favor, even strong companies might take a hit, which can lead to companies becoming undervalued.
Example: Enterprise Products Partners (EPD) in 2020 was heavily discounted as oil prices collapsed due to pandemic-driven demand destruction. As a midstream energy company, EPD transports and processes oil and natural gas rather than drilling for it, meaning its revenue is less sensitive to commodity price swings than upstream producers.
Despite this, its stock dropped significantly alongside the rest of the energy sector. However, as demand for oil and natural gas recovered in 2021 and 2022, EPD rebounded, benefiting from stable cash flows and high-yielding distributions.
The stock paid double-digit dividend yields for investors who bought in March of 2020, and saw a 100%+ 5-year price return:
Lack of Wall Street Coverage
Smaller, underfollowed stocks often trade below fair value due to lower investor awareness.
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How Can You Tell if a Stock is Undervalued?
A stock is undervalued when its price is lower than what the company is actually worth based on its future earning potential. (Here’s how to value a stock in under 2 minutes.)
Here are some strategies to value a stock, as well as some metrics to see if a stock is undervalued:
Stock Valuation Methods
Here are some of the most common methods to value a stock:
- Price-Based Metrics: Comparing a stock’s price to earnings (P/E ratio), book value, or sales (EV/Revenue) to similar companies.
- 2-Minute Valuation Model: Value stocks by forecasting an appropriate earnings-per-share and using an appropriate P/E multiple.
Here are some of the best metrics to use to find undervalued stocks and when to use them:
Key Metrics to Find Undervalued Stocks
It can be helpful to look at a stock’s valuation metrics to see if it is undervalued.
These are some of the best valuation metrics to use:
1. Price-to-Earnings (P/E Ratio)
- Best for: Stable, profitable companies
- How it works: Measures how much investors are willing to pay for each dollar of earnings.
- What to look for: A low P/E ratio compared to industry peers may signal undervaluation, but always consider growth potential.
- Example: In early 2023, Meta (META) had a P/E ratio below 15 despite strong ad revenue and cost-cutting measures. Investors who recognized this as a temporary overreaction saw significant gains.
2. Price-to-Book (P/B) Ratio
- Best for: Asset-heavy businesses (banks, real estate, manufacturing)
- How it works: Compares the stock price to the company’s book value (assets minus liabilities).
- What to look for: A P/B ratio below 1 suggests the stock may be trading below its net asset value, but check asset quality.
- Example: Bank of America (BAC), after the 2008 crisis, traded at a P/B ratio below 1 despite having valuable deposits and assets.
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3. Enterprise Value to Revenue (EV/Revenue)
- Best for: Growth companies with little or no profit
- How it works: Compares market cap to revenue, helping assess valuation when earnings are inconsistent.
- What to look for: A low NTM EV/Revenue ratio relative to historical averages or competitors can show that a stock is undervalued.
- Example: In 2022, Shopify’s (SHOP) forward EV/Revenue ratio dropped below pandemic lows despite continued e-commerce growth. The stock has 3x’d since then.
4. Enterprise Value to EBITDA (EV/EBITDA)
- Best for: Capital-intensive businesses (energy, telecom, industrials)
- How it works: Measures a company’s value relative to its earnings before interest, taxes, depreciation, and amortization.
- What to look for: A lower EV/EBITDA ratio suggests the stock is cheaper on a cash flow basis.
- Example: AT&T (T) has historically traded at low EV/EBITDA multiples, making it an attractive buy during market downturns.
5. Discounted Cash Flow (DCF) Analysis
- Best for: Companies with predictable cash flows
- How it works: Estimates the present value of a company’s future cash flows.
- What to look for: A stock is undervalued if its DCF valuation is significantly higher than its market price.
- Example: In 2020, Google (GOOGL) traded at a price well below its DCF valuation, making it a long-term buying opportunity.
6. Analyst Price Targets
- Best for: Cross-referencing against valuation metrics
- How it works: Analysts assign price targets based on financial models and industry trends.
- What to look for: A stock trading well below its average analyst price target may indicate upside potential, but always verify with fundamental analysis.
- Example: In 2023, PayPal (PYPL) had price targets nearly 50% higher than its stock price. The stock has seen a nearly 50% return in the past year.
By focusing on these valuation metrics and cross-referencing with fundamental analysis, investors can avoid value traps and identify stocks that are truly trading below their intrinsic value.
The next step is to learn how to use stock screeners to find these opportunities efficiently.
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How to Find Undervalued Stocks with Stock Screeners
Stock screeners help you filter the whole investing universe for stocks that fit your criteria.
Here are some screens you can use to find undervalued stocks on TIKR’s stock screener:
1. Value Screener
This screener helps you find stocks that have fallen over 20% this year but are still expected to see growing revenue and EBITDA margins.
This also filters just for US companies that are valued at over $1 billion:
Notable Stocks: Abercrombie & Fitch (ANF), ZIM Integrated Shipping Services (ZIM), m
2. ROIC Champs
This screener helps you find stocks that see excellent shareholder profitability, with over 25% returns on capital in the last 12 months.
These stocks are also expected to grow revenue and operating income at over 5% annually over the next 3 years, while trading at less than 5 times revenue:
Notable Stocks: PDD Holdings (PDD), O’Reilly Automotive (ORLY), Lululemon Athletica (LULU), Domino’s Pizza (DPZ)
3. High-Growth Screener
This screener helps you find fast-growing companies that are expected to grow revenue at over 25% annually while increasing gross margins.
These businesses have to have more cash on hand than total debt (negative net debt filter), and they have to be cheap, with a filter of 30 times next year’s expected earnings:
Notable Stocks: Nu Holdings (NU), First Solar (FSLR), Rocket Lab USA (RKLB), Riot Platforms (RIOT)
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Follow Investing Gurus to Find Undervalued Stocks
One of the best ways to find undervalued stocks is by tracking the investment decisions of legendary value investors.
You can find new investing ideas by:
- Look for new positions and increased stakes
- Compare positions to current stock prices: A stock might be even cheaper now than when the investor first bought it.
- Avoid stocks that are already up significantly: The best opportunities are when a stock is still undervalued.
With TIKR’s Track Investing Gurus feature, you can follow the holdings of the world’s top investors.
TIKR aggregates public filings that these investors must disclose, so you can quickly see what stocks these investors hold.
Who Are the Best Value Investors to Follow?
- Warren Buffett (Berkshire Hathaway): Focuses on high-quality companies with strong moats and long-term value.
Berkshire recently added to their Occidental Petroleum (OXY) position.
The stock is down 8% in the past 3 months, which means the stock’s still available at about the same price that Berkshire was buying:
- Michael Burry (Scion Asset Management): Contrarian investor who looks for deeply mispriced stocks.
- Mohnish Pabrai (Pabrai Investment Funds): Invests in companies with strong fundamentals trading at a discount.
- David Einhorn (Greenlight Capital): Specializes in value stocks with near-term catalysts.
Greenlight recently added to their HP Inc (HPQ) position.
HP stock is down 2% in the past 6 months, which means the stock’s still available at about the same price that David Einhorn was buying:
Common Mistakes When Searching for Undervalued Stocks
Value investing isn’t just about finding cheap stocks, it’s about finding stocks that are trading for less than they’re worth. Investors will want to avoid making these mistakes:
Falling for Value Traps
A low P/E doesn’t always mean a stock is undervalued. Companies in declining industries or with unsustainable business models often trade at low valuations for a reason.
Example: Kodak (KODK) and Blockbuster were “cheap” before going bankrupt.
Ignoring Future Growth Potential
A stock trading at a low multiple but lacking a catalyst for future growth may stay cheap.
Example: IBM (IBM) has traded at low valuations for years due to stagnant growth.
Overreliance on a Single Metric
Investors should never rely on just one metric like P/E ratios.
Always combine multiple valuation methods with qualitative analysis.
Frequently Asked Questions (FAQs)
1. What is the best way to find undervalued stocks?
The best way to find undervalued stocks is by using a mix of fundamental analysis, stock screeners, and business research. Look for low valuation ratios, but also check a company’s financial health, competitive edge, and leadership quality to avoid bad investments.
2. How can I use TIKR to find undervalued stocks?
To find undervalued stocks on TIKR, use its stock screener to filter for low P/E, P/B, or EV/EBITDA ratios. TIKR also provides analyst forecasts and earnings call transcripts to help verify whether a stock is truly a bargain.
3. Which valuation metric is most reliable for finding undervalued stocks?
The best valuation metric depends on the company’s industry and business model. P/E works well for profitable companies, P/B for asset-heavy businesses, and EV/EBITDA for capital-intensive industries, while DCF is best for companies with steady cash flows.
4. How do I know if a stock is undervalued or just a value trap?
A stock is undervalued if it has strong financials and future growth potential, while a value trap stays cheap due to declining revenue, poor management, or high debt. Check for consistent earnings growth, a competitive advantage, and sustainable cash flow to avoid value traps.
5. What are some recent examples of undervalued stocks that made a strong return?
MMeta (META) rebounded in 2022 after cutting costs and ramping up AI investments. Amazon (AMZN) was undervalued in 2014 but surged as its cloud business, AWS, became a major profit driver. Occidental Petroleum (OXY) soared in 2022 after Warren Buffett increased his stake, seeing long-term value in the company.
TIKR Takeaway
Investors who focus on finding undervalued stocks with solid fundamentals might be able to spot strong businesses with growth potential before Wall Street catches on.
The TIKR Terminal offers industry-leading financial data on over 100,000 stocks, so if you’re looking to find the best stocks to buy for your portfolio, you’ll want to use TIKR!
TIKR offers institutional-quality research for investors who think of buying stocks as buying a piece of a business.
Disclaimer:
Please note that the articles on TIKR are not intended to serve as investment or financial advice from TIKR or our content team, nor are they recommendations to buy or sell any stocks. We create our content based on TIKR Terminal’s investment data and analysts’ estimates. We aim to provide informative and engaging analysis to help empower individuals to make their own investment decisions. Neither TIKR nor our authors hold any positions in the stocks mentioned in this article. Thank you for reading, and happy investing!
