How to determine whether a company is overvalued or undervalued?

When a company's market value is above or below its estimated intrinsic value, it is either overvalued or undervalued. Performing a fundamental analysis is necessary in order to calculate this fair value.

The introductory study of a company evaluates its value based on many financial factors, including the following:

●     P/E ratio: It shows the ratio between a company's share price and earnings per share. P/E ratios that are lower than peers or their historical level might indicate undervalued companies.

●     P/S ratio: It shows the ratio between a company's share price and its sales/revenue per share. P/S ratios below the industry average may indicate a company's undervaluation.

●     PEG ratio: It is also called Price/earnings-to-growth. A company's P/E ratio can determine its value.

●     P/B ratio: It is the ratio between the stock price and book value per share. If the ratio is lower than 1, a company's shares are trading for less than its total assets are worth, which may indicate an undervalued company.

●     Dividend yield: This ratio shows how much a company pays in dividends compared to its yearly stock price. Shareholders prefer companies with a stable dividend yield.

●     Debt-equity ratio: It is the ratio between debt and shareholder equity. It is essential to compare the ratio to the industry average since a high percentage indicates that the company is more dependent on borrowing money.

●     Earnings yield: It shows the ratio between earnings per share and share price. Earnings yield, which is low compared to Treasury yield, may reveal an overvalued company. Earnings yield higher than a Treasury yield may indicate undervalued stocks.

●     Current ratio: It is the ratio between assets and liabilities. When this ratio is less than 1, a company cannot cover its debts with its holdings in a short-term period and may face financial difficulties.

●     Return on equity: It is the ratio between net income and shareholder equity. Investors look for an undervalued company that has a high return on equity as one indication.