Friend,
The question is appropriate. When we go to the market for investment, we often hear two words.
1)undervalued
2)Overvalued
For an investor, both these words are very important. From the trader's point of view, it does not have much importance.
Let's learn something new today as per the question. The post will just become a little longer.
In simple words, we can call undervalued stocks cheap stocks and overvalued stocks expensive stocks.
Now you must be thinking that it is very easy to tell which stock is undervalued and which is overvalued.
Wait, it is not that easy. Many investors get ruined in the process of understanding this easily. You will say how?
Tell me one thing...the price of one stock is Rs 1000 and the price of another stock is Rs 50. Which is the cheaper stock among the two?
Obviously, most new investors will say what is the big deal in this. The one which is trading at 50 is the cheaper stock.
This is the mistake most investors make in the market.
It is not necessary that the stock which has a low price is cheap and the stock which has a high price is expensive.
Most stocks in the market are trading above or below their actual value. That is, the actual price of the stock should have been something else but due to some reason the stock is trading above or below that.
I know you must be thinking how is it possible that a stock trades at a higher or lower price than its actual price.
Let us understand this also. Suppose XYZ stock is currently trading at Rs 100. But then at the same time some positive news comes in the market about that stock that the government can give a big project to that company. As soon as this news reaches the market, people consider it positive and start buying it. Due to this purchase, the price of the share increases from 100 to 150.
But it is worth noting that right now the government has only talked about giving the project.. it has not given it yet. If the price had increased after giving the project, then it would have been the actual value, but right now the government has only thought of giving it. Therefore, the actual value of the share is currently also Rs 100. If it is trading at 150, it means that the share is trading 50 rupees more expensive.
In such a situation, it is necessary for an investor to find out before investing whether the share to be bought is currently trading at the actual value or above or below it.
If the share is trading above the actual value, then it will be called over-valued. On the other hand, if it is trading below the actual value, then it will be called under-valued.
There are many ways to calculate this. Let's discuss it in a next post. Because the question was only to understand these two points.
Hope the post will be useful for you.
Thank you
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