What Are the Criteria for Undervalued Stocks?


Quick Answer

Undervalued stocks, also known as value stocks, meet criteria regarding company quality ratings, price-to-book values and the ratio of price-to-earnings per share, explains Cabot Investing Advice. These criteria form part of a value investing strategy developed by Benjamin Graham in the 1920s.

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One method of identifying undervalued stocks is checking the price-to-book ratio of a target company, suggests Cabot Investing Advice. These ratios divide the present stock price by the most current book value per share. Companies with ratios below 1.20 have undervalued stock and may make good investments.

Another method of determining the value of a stock is probing the price-to-earnings per share ratio of the issuing company, recommends Cabot Investing Advice. Undervalued firms have ratios under 9.0.

Another approach that can pinpoint undervalued stocks is examining the current ratio of a company, suggests Cabot Investing Advice. Calculated by dividing current assets with current liabilities, the current ratio verifies that a firm has enough assets to weather economic downturns. The ideal current ratio is 1.50 or more.

To avoid investing in companies saddled with excessive debt, investors should check the total debt-to-current asset ratio of a target company, warns Cabot Investing Advice. Information on these ratios is available from financial services firms such as Value Line and Standard & Poor's. Ideally, the total debt-to-current asset ratio should be less than 1.10.

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