Value Line University

Stock Valuation

You might hear a stock described as overvalued or undervalued. That's generally a comment on how much investors are currently paying for the stock in relation to the valuations of other stocks.

An overvalued stock is often one whose P/E ratio is high relative to the rate at which a company's earnings are likely to grow. In some cases, the future performance of these stocks may not be able to sustain the high expectations implicit in the price investors are paying. However, overvalued stocks often get positive press coverage, which builds enthusiasm for the stock and elevates the price even more, at least for a time. Then, in a downturn, the price typically falls until the stock's P/E is more in line with the median P/E of the approximately 1,700 stocks in the Value Line universe.

In contrast, an undervalued stock is selling at a P/E that is modest relative to other stocks in the Value Line universe. Investors who seek out these stocks can reap the benefit of strong future performance, assuming that enough investor attention shifts to their merits and demand for the stock increases, so that the price rises.