Imagine finding the coolest store in a mall silently during a sale, when everyone else is running after shiny and trendy stores. Amid the chaos of a bull market, finding an undervalued stock that is being sold at a fraction of its worth is a blessing indeed! You must keep a keen eye on the markets while everyone else is running after the growth stocks and market hype that is being generated. This is what separates a savvy expert in the stock market from the herd. Let’s dive into how one can easily spot undervalued stocks in the chaos of the bull market.
What is undervalued in a bull market?
If a stock is trading below its intrinsic value, it is called an undervalued stock in simple terms. In the case of a bull market, rising tides tend to lift all boats, making it difficult to catch hold of an undervalued stock. The market is in a euphoric mood, which makes even the mediocre stocks look promising, making it even more challenging to find the correct stocks that are actually undervalued.
What makes a stock undervalued? Well, there can be n number of reasons, but the highly common ones include market overlook, short-term challenges, and information gaps. These issues are the highly common reasons for a stock being undervalued. If a stock belongs to an industry that is being overlooked, or if it belongs to a smaller company, these issues might arise.
The perfect toolkit for success
You need more than just intuition to identify undervalued stocks, you must have a systematic approach. Here are a few strategies that you can employ.
Start with fundamental analysis
Analyze the economic condition of any company to ensure a strong value-trading foundation. You can make use of ratios like the Price-to-earnings ratio, Price-to-book ratio, Debt-to-equity ratio, and more to understand the fundamentals better. It is also beneficial to take a look at the cash flow of the firm as well. You can easily identify and weed out the overhyped stocks and companies using the ratios mentioned above as a filter.
Look beyond the headlines
You get to hear a lot of noise in a bull market. You can often find greater value in areas where there is minimal noise or attention. For example, focusing on small-cap stocks or even underperforming sectors can be a beneficial choice in this regard. Small-cap stocks might have a high potential but are lacking the spotlight, which larger firms have. Underperforming sectors during a bull run are at a greater chance of having underperforming stocks.
Analyze insider activity
You can easily understand the confidence of the market on a stock when the executives buy or sell the stock. This can be seen as a goldmine of information if you are looking for underperforming stock. If insider buying of stocks is increasing, it means that the potential for growth of that particular stock is high.
Use advanced tools
Make use of advanced tools to dig deeper into the markets and find the hidden gem! You can use the discounted cash flow (DCF) model to find the intrinsic value of a stock. If you are using this model, you can easily assess whether the future earning potential of the stock is aligned with its current prices or not.
You can also make use of relative valuation metrics to dig in deeper. From comparing stock’s metrics with the current industry averages to identifying outliers you can take all kinds of measures. Finding outliers suggesting that the stock value is not recognized can be a helpful indicator as well.
Stocks that have a higher trend of upward revisions indicate that their fundamentals are improving. Tracking the earning revisions of analysts can be a beneficial way of finding undervalued stocks as well.
Major risks that you must be wary of
Did you think that identifying an underperforming stock during a bull market would be a cakewalk? Even for the highly savvy experts, it is an extremely difficult task, as no strategy is foolproof in the current dynamic markets.
One major risk is that of value traps, as some stocks appear undervalued but also lack a clear catalyst that can trigger their growth.
Weaknesses in seemingly undervalued stocks can again be exposed due to macroeconomic shifts, as bull markets can take sudden shifts as well.
If you ignore the qualitative factors and run after numbers only, it can again be a massive risk. Numbers might give you the correct story, but qualitative factors like management quality or market positioning can play an important part too.
The long game
Patience is an important need if you are working with undervalued stocks. If you want your trades to thrive in every market cycle, you need to select the correct stocks. You must understand that a bull market does not last forever under any scenario. You must be looking for long-term success in stock trading, isn’t it? Then the key is to build a portfolio that consists of a balance of hidden gems and high-growth opportunities.
If you are a good trader, there are several opportunities available for you in a bull market. However, remember, these opportunities have their challenges. A bull market can help you make fast gains, making it an exciting phase in the life of a trader. But you need to take notice of the fundamentals and stay grounded even in those times. You should look beyond the obvious and use the correct tools that can help you to identify underperforming stocks.
If you are into trading, you must not blindly follow the crowd. If you do so, you are completely doomed! Create your way and think differently to stay ahead of the crowd. Remember one thing, even if the market is rising, there is a high chance that the valuable stocks are not the popular ones. Use tools and ratios to identify stocks that are underperforming. It will help in maintaining a better portfolio that is stable and can give you good returns constantly.