How to Find Undervalued Stocks in 2022

Jitanchandra Solanki
16 Min read

Identifying undervalued stocks - companies whose share price is trading below its 'fair' value - has long been the quest of hedge fund managers, legendary investors like Warren Buffett and individual traders and investors alike. But of course, finding high-quality undervalued shares and buying them in the hope of trading them back to 'fair' value requires some know-how.

In this 'How to Find Undervalued Stocks in 2022' article, you will learn what undervalued stocks are and how to find them, the most important financial ratios to find the 'fair' value of a company and the top stocks of 2022 and how you can trade them.

What are Undervalued Stocks?

An undervalued stock is a publicly-traded company whose share price is lower than its 'fair' value. You are probably thinking how a company can ever get in that situation as surely a large hedge fund or investor in 'the know' will have snapped up the undervalued shares pretty quickly. The reality is that there are many different reasons why a stock could be undervalued, such as a:

  • Market crash: In a market panic investors typically think emotionally rather than rationally. This means panic selling can cause a decoupling between an asset's current price and 'fair' value.
  • Company-specific problem: There are times when a company may go through some fundamental issues caused by negative news, fraud, a scandal or even political and economic changes. This means the company's share price may drop significantly if investors choose to sell and invest elsewhere until the problem gets resolved.

Investors would typically use these scenarios to buy undervalued shares due to the fundamental assumption that the share price will correct back to the asset's 'fair' value over time. However, an undervalued stock is not necessarily just any stock that is cheaper than it was before. The key is to look for high-quality stocks whose share price is under its 'fair' value, rather than just at a low price.

A good example would be to use the investing ethos of legendary investor Warren Buffett. Dubbed the 'Oracle of Omaha', Buffett learnt his trade from the 'father of value investing' Benjamin Graham. Their ethos is to buy undervalued stocks of high-quality companies that will grow over the next five, ten and 15 years.

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Identifying Undervalued Stocks using Financial Ratios

There are a variety of ways to find undervalued stocks. The most common fall into a form of fundamental analysis or technical analysis but usually a combination of both.

There are two types of fundamental analysis: a top-down analysis and bottom-up analysis. In a top-down analysis, an investor would first analyse the bigger picture or the broader economic trend before finding companies that could perform well in such times. The bottom-up approach involves analysing a company's fundamentals first and then looking at the bigger picture.

Technical analysis is quite different and only involves the analysis of a company's share price. Traders would typically look for repeated chart patterns and use technical indicators to find suitable stocks to trade on.

Nowadays, most traders use a combination of both types of analysis. However, when identifying undervalued stocks there are some very specific financial ratios and metrics investors like Warren Buffett and Benjamin Graham would use. Let's take a look at some of these.

1. Price to Earnings Ratio (P/E)

The price/earnings (P/E) ratio compares a company's stock price against how much profit the company is making. It is one of the most popular ways to measure a company's value.

The P/E ratio is calculated by taking the current price of a stock and dividing it by the company's earnings-per-share number. A low P/E ratio could mean the company's stock price is undervalued. This is because you're paying less (the price) for the amount of profit the company is generating (the earnings).

While the ratio by itself is a useful metric it becomes more powerful when compared to the industry average. For example, the P/E ratio of an energy company like British Petroleum (BP) would be compared to the P/E ratio of other energy companies like Royal Dutch Shell. If a company's P/E ratio is below the industry average it could be a sign the stock price is undervalued.

2. Price to Earnings Growth Ratio (PEG)

The price to earnings growth ratio (PEG) looks at the P/E ratio compared to the percentage growth in annual earnings per share, usually for the next five years. This gives investors a sense of the company's future earnings potential.

PEG is calculated by taking the P/E ratio and dividing it by the expected annual earnings per share growth rate. Investors would typically look for a company with a low PEG as these companies are considered as undervalued. The PEG ratio is typically seen as a more reliable indicator when trying to identify undervalued stocks.

3. Price to Book Ratio (P/B)

The price to book ratio (P/B) is used to measure a company's stock price to the company's book value. A company's book value is the value of its assets minus liabilities, divided by the total amount of shares issued.

The P/B ratio is calculated by dividing the company's market price per share by its book value per share. This tells the investor how much money they would get if the company was liquidated. Investors would typically look for a P/B ratio of between zero to one to indicate a potentially undervalued company.

4. Return on Equity (ROE)

The return on equity (ROE) ratio measures a company's overall profitability against is equity. The ratio is calculated by dividing the net income of the company by its shareholder equity. The outcome is a percentage based figure.

A high return on equity (ROE) figure shows the company is generating a high income relative to the amount shareholders have invested. In this scenario, the company would be deemed as potentially being undervalued.

5. Dividend Yield

The dividend yield is a popular quoted financial ratio. It is used to describe the ratio between a company's annual dividends and its share price. Dividends are the portion of profits that are paid to shareholders.

To calculate the dividend yield, you simply divide the annual dividend by the share price. Companies with solid dividend yields are more likely to be stable and return profits to shareholders. You can learn more about dividends in the 'Best Dividend Stocks for Income' article.

Did you know that you can access fundamental and technical analysis research tools from the Admirals Premium Analytics section? When you open an account have a look at the extra tools that can help you make better and more informed decisions regarding the markets you are trading. 

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Three Undervalued Stocks for 2022

The impact of the coronavirus pandemic and the Russia-Ukraine war in early 2022 led to a sell-off in global stock markets. This has led to some high-quality companies now trading at undervalued levels, far away from their 'fair' value. Below are just a few to consider for this year.

1. Boeing - One of the most undervalued stocks in the aerospace sector

Boeing (BA) was once the most successful company in the United States. However, the aerospace giant has had a very tough few years. In fact, nearly all air travel companies were affected by the coronavirus lockdown and geopolitical tensions at the start of 2022. While most of these stocks are lower, Boeing shares have dropped nearly 80% from the record high in March 2019 to a multi-year low in March 2020.

In 2021, this led the company's share price to be trading at a price to earnings ratio of -20.02 which - according to this ratio - means the stock is undervalued. However, the key to value investing is to find high-quality companies that can move back to the 'fair' value. For 2022, analysts are forecasting a price to earnings ratio of 53.83. 

While Boeing was nearly on the brink of bankruptcy the Fed's decision to purchase corporate bonds allowed the aerospace company to raise $25 billion from private investors. Analysts are cautiously bullish on the aerospace sector. While Boeing has had issues with the safety of some of its aircraft an increase in air travel could help the company in the long term. 

Source: Admirals MetaTrader 5, #BA, Monthly - Data range: from 1 Apr 2007 to 28 Mar 2022, accessed on 28 Mar 2022 at 11:22 am BST. Please note: Past performance is not a reliable indicator of future results.

The monthly price chart of Boeing's share price shown above highlights the huge decline in its share price during 2019 and 2020. However, it also shows the share price stabilising at the $105 price level which is also a strong horizontal support level where buyers have turned up before in 2015. Traders would often use these types of technical analysis levels to trade from, as well as a target.

While the share price has already risen from this horizontal support level, investors will be looking for a break back above the previous swing high of circa. $279 for confirmation of an uptrend. This would trigger a higher high price cycle which will confirm the uptrend. But as this stock is still undervalued it presents an interesting opportunity for the long term. 

2. General Motors - Is the pause in dividend payments actually a positive sign?

General Motors (GM) is an American multination company that is home to car brands such as Chevrolet, Buick, GMC and Cadillac. The company which is headquartered in Detroit manufactures vehicles in 15 countries.

The auto industry is very cyclical with higher car purchases in the summer than the winter. The impact of the coronavirus stalled large purchases as more individuals lost their jobs or became furloughed. There are still major supply constraints that have developed as China still deal with a resurging Covid wave. There are other factors that class General Motors as an undervalued stock. 

The company has a low price to earnings ratio of 6.17 in 2021 which is expected to grow to 6.51 in 2022. At the beginning of 2022, the company also announced plans that it will not reinstate its dividend at this time - even in spite of record profitability. This immediately weighed on the share price but the company's plan is to use the excess capital to accelerate its electric vehicle plans which is a huge growth sector. 

Therefore, there are reasons why General Motors (which has been recording good profitability in recent earnings reports) is considered a strong company that could be classed as an undervalued stock. 

Source: Admirals MetaTrader 5, #GM, Monthly - Data range: from 1 Nov 2010 to 28 Mar 2022, accessed on 28 Mar 2022 at 1:22 pm BST. Please note: Past performance is not a reliable indicator of future results.

The above price chart of General Motors' historic share price shows that the stock price has broken out of a long-term consolidation chart pattern, as denoted by the upper black horizontal resistance line and lower black horizontal support line. The price is now retesting the top of the trading range and could be a price level in which buyers start to build positions once again. 

3. Carnival - A long-term stock for patient investors

Carnival (CCL) is a British-American cruise operator that currently has the world's largest fleet with over 100 vessels across 10 cruise line brands. As governments enforced the 'non-essential travel' restriction due to the coronavirus, cruise line companies and most other types of travel and leisure companies felt the pinch.

In fact, Carnival's share price has been in a steady decline since the beginning of 2018, falling nearly 90% lower. However, the situation presented by the coronavirus is forcing companies to change business structures and models, leaving the bigger players in an industry to take control.

If Carnival can survive the crisis, it could be in a good position to lead the way higher as demand picks up, although this is a long-term situation as covid-variants such as delta and omicron have mooted demand for cruise line travel.

Carnival shares are dual-listed on the London Stock Exchange and New York Stock Exchange.  Currently, the US-listed shares have a price to earnings ratio of 7.3 which is below the market average for US companies of 16.9, classing Carnival as an undervalued stock. 

Analysts are forecasting for the world's biggest cruise operator to start growing meaningfully in 2023, presenting some interesting opportunities for long-term, patient investors today. 

Source: Admirals MetaTrader 5, #CCL, Monthly - Data range: from 1 Sep 2004 to 28 Mar 2022, accessed on 28 Mar 2022 at 2:22 pm BST. Please note: Past performance is not a reliable indicator of future results.

The Carnival share price has been hovering around multi-year lows not seen since 2008 (the black horizontal line in the chart above). However, this could be a platform for longer-term investors to build positions in the company. A break above the recent swing high at circa. 1,923.00 would confirm the potential of an overall uptrend developing. 

You can learn about the themes that are developing in the markets right now by registering for your free access to the Admirals' live trading webinars hosted three times a week. 

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How to Invest in Undervalued Stocks in 4 Steps

With Admirals, you can buy shares in US companies with a competitive commission of just 0.02 USD per share and with a low minimum commission of just $1.0. You can also invest in UK companies with a competitive commission of just 0.1% of your investment value with a low minimum commission of £1.0.    

  1. Open an account with Admirals to access the Trader’s Room.   
  2. Click on Trade on one of your live or demo accounts to open the web platform.   
  3. Search for your undervalued stocks name at the bottom of the Market Watch window and drag the symbol onto the chart.   
  4. Use the one-click trading feature, or right-click and open a trading ticket to input your trade size, stop loss and take profit level.   

Source: Admirals MetaTrader 5 Web. Past performance is not a reliable indicator of future results, or future performance. 

Why Invest in Undervalued Stocks with Admirals?

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About Admirals

Admirals is a multi-award winning, globally regulated Forex and CFD broker, offering trading on over 8,000 financial instruments via the world's most popular trading platforms: MetaTrader 4 and MetaTrader 5. Start trading today!

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or recommendation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

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