Not all stocks are the same. To help investors pick up the one that best suits their needs, stocks have been classified on different aspects including classes, market capitalisation, dividend payment, risk, etc. Fundamentals is one of those aspects. Let’s learn more about the types of stocks based on this aspect.

Meaning of stock fundamental

In the broader term, stock fundamentals refer to analysis of data besides the trading pattern of stock, which can impact its price. It attempts to predict and understand the intrinsic value of stocks based on an in-depth analysis of several economic, qualitative, quantitative and financial factors.

Stock types based on fundamentals

Based on stock fundamentals, there are two types of stocks:
  • Overvalued stocks
  • Undervalued stocks

Overvalued stock

An overvalued stock is one whose current price isn’t justified by its profit projections or price-to-earnings (PE) ratio. PE ratio is found by dividing a stock’s price by its trailing 12 months’ earnings per share. For instance, if a stock is trading at Rs. 10 and its earning in the past year was Rs. 2, then it’s PE ratio would be 5 (10/2). To simply put, the stock is said to be trading at five times its earnings.

There are two ways through which a stock can become overvalued:
  • First, if there’s a surge in its demand, driven by investors’ perception. However, this perception is not justified by the company’s actual financial status.
  • Second, if its fundamentals (i.e revenue, growth projection, etc.) decline while its market price remains constant.

It’s important to note that an overvalued stock is likely to experience a price decline in the near future, which will better reflect its financial status. Investors must be cautious while investing in these stocks.

Undervalued stock

An undervalued stock is just the opposite of an overvalued one. These are stocks which trade at the price lower than its fair market value. The reasons for a stock’s undervalue are:
  • Decline in its demand due to lack of investors’ confidence
  • Rapid improvement of a company’s fundamentals, while its market price remaining constant

Investing in an undervalued stock can prove to a profitable bet since prices of these stocks are expected to go up in the coming days. Thus, you stand a better chance of earning high returns on your investment in the near future, should you invest in an undervalued stock.

The final word

To find whether a stock is overvalued or undervalued, it’s essential for investors to go through the company’s annual reports, profit and loss accounts, balance sheet or any other development related to it or the sector in which it’s carrying out operations.
It’s ideal to avoid a company which has huge debt. It’s also vital to know about the company’s management and its background as of these have an impact on the price of a stock.

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The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.

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