the biggest potential are in the smaller companies. Large companies can not grow much faster than the economy generally speaking. Undervalued is a somewhat more difficult characteristic to determine. One method used is to compare its current valuation against its historic valuation–ie p/e ratio, p/s ratio, p/b ratio, debt/equity, roa, profit margin, etc. Not only against its historic valuation but also against its competitors. Some companies are undervalued for good reason. They might be poorly run. They might be facing foreign competition. They might be serving a dying market. In other words they may not actually be undervalued. For example does Ford actually have any value any longer?
Another method that is popular is called discounted cash flow. You take the future cash flow of the company and discount it to give the company a present value and compare that to the price it is currently selling at. This has become very popular. Only problem is is that it is all based on speculation. What is the future cash flow likely to be? What should the discount rate be?
Of course if it were easy, then stock prices would not fluctuate so much if at all.
How about our taking an example.
LECO This is a smaller company with sales of 2.28 billion and a market cap of 2.86 billion. P/E is 14. P/S is 1.12 P/B is 2.56 D/E is 0.12. ROA 11.4%
How does that compare to its history?
5 yr averages roa 10.4% p/e 16 p/b 2.64 p/s 1.16 d/e 0.25
Comparing current valuations against the 5 year norm we see the p/e is down by 2, d/e is down, roa is up p/b is down slightly and p/s is down slightly
What is the earnings and sales growth rate like? revenue growth rate over last 5 years is 18% year over year only 16%
earnings growth rate last 5 years 25% year over year only 19% EPS growth rate last 5 years 25% year over year only 15%. The growth rate is slowing some, but the company is growing current year at 15% in eps and the pe is below the historic average and below the growth rate. From this data alone the company appears to be at least 15% undervalued.
Lets compare it to the industry and the market
LECO pe 14 Industry pe 19 S&P 18
p/b 2. 2.9 3.8
p/s 1.3 1.7 2.5
roa 13.3 4.3 8.6
compared to everything else LECO appears dirt cheap.
I will not even attempt to go through the discounted cash flow nonsense.