What is Overvalued Stock or an Undervalued Stock

An overvalued stock can be understood as an inflated hope that a company will do well.

Thus, a stock is overvalued if its current price exceeds the intrinsic value of the stock. The market may temporarily price stocks too high or too low and that's how investors determine whether stocks are being overvalued or undervalued.

If a stock is overvalued, the current price of the stock exceeds its earnings ratio (PE ratio*) and hence investors expect the price of the stock to drop. A high PE in relation to the past PE ratio of the same stock may indicate an overvalued condition, or a high PE in relation to peer stocks may also indicate an overvalued stockthus the PE ratio is one of the many ways to determine whether a stock is overvalued.

*A company's P/E ratio is computed by dividing the current market price of one share of a company's stock by that company's per-share earnings.For example, a P/E ratio of 10 means that the company has Rs1 of annual, per-share earnings for every Rs10 in share priceA stock is undervalued when, if is selling at a much lower price than what it is actually worth.

This can be determined based on fundamentals like earnings and growth prospects. One of the best-known measures for finding an undervalued stock is the price earnings ratio (P/E).

Consider Colgate and Pepsodent, which are in the same industry and have similar fundamentals. If Colgate has a P/E of 15 and Pepsodent's is 20, Colgate could be an undervalued stock.