How do you determine if a stock is over-valued or under-valued?

Question

Is there a formula that you can use to determine this? What is it?

Answer 1

It is never an easy task to determine if a stock is over or under valued.  You could look at a company's historical PE ratio and compare it to the current PE, but there are so many other factors to consider.  If you look at the stocks or industries that are really beaten down, you could make a case for them being under valued but they could stay that way for a long time.  The same could be said for stocks everyone loves.  If everyone likes it, then you probably want to get out.  Sorry, no easy formula.

Answer 2

Phil Town's book Rule #1 explains a good method; there's a free calculator available at his website:

http://www.philtown.com/

Quick rule of thumb: if the expected growth rate for the next five years (see Yahoo finance page for the stock and analyst estimates) is lower than the PE ratio, then the stock is a good value.

Answer 3

If it goes down after you bought it, it was over-valued.

There's also its P/E, but predicting the future from any metric is doomed to failure. There is actually an axiom that the more you study stocks, the more wrong you will be.

You've heard about the chimpanzees that did a better job picking stocks than the experts. Same thing happened with Playboy Playmates, darts on a newspaper, etc.

Answer 4

There are several math formulas which are often outdated. They don't work if everyone knows about them because if everyone knew who was going to win the race gambling wouldn't exist and the same fate happens here.

One is common sense.  I'm sure you saw the Bennie Baby craze and what happened there.  The same thing happens with stocks, especially biotech and out there science.   If you knew that fuel prices were going to greatly rise just 5 years ago, you probably would have bought energy stocks.  Here is a bit of data, 75 million Americans will have turned 65 years old in the next 15 years or so.  They are going to need things as they get old, a lot of things so you should look into companies that make those things.  They are going to be popping more pills, getting electric carts, going into rest homes (yes there are rest home stocks) etc.

Find your idiots in the newspaper or online.  As you probably know you want to buy low and sell high.  Some people are the reverse.  They want to buy high and sell low each and every time.  Those are the idiots you want to look for.  Right now they are probably just now buying gold and oil and not wanting to touch real estate.  You might want to do the reverse.  You may buy a down beaten REIT now and then sell when housing recovers.  That's called contrarian investing or going against the herd.

Answer 5

There are many ways to measure whether a stock is overvalued.  Price to earnings (P/E) is a good one.