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What do people mean when they say a stock is “undervalued”?

An undervalued stock is one that is trading below its estimated value in the market, usually measured by the price/earnings ratio. Undervalued stocks are considered attractive for investors, since the price/earnings ratio is low. You might also hear these stocks or shares referred to as “value stocks”.

The price-earnings ratio, or P/E ratio, is calculated by dividing the common stock’s current price by the company’s earnings per share, like this: P/E Ratio = Market Price per Common Share/Earnings per Share (in latest 12-month period) Example: $36.35/3.00 = P/E Ratio is 12.12:1 or 12.12 times It’s a short way of saying that a share is selling at (in this example) 12.12 times its annual anticipated earnings. You will also hear this ratio referred to as the “multiple”. P/E ratios are used to compare one share to another within the same industry. For example, if you were to decide you wanted to invest in the retail sector, you might compare the P/E ratios of Canadian Tire versus Home Depot to help you make your decision. P/E ratio averages vary between industries, from typically higher multiples in the pharmaceutical sector to lower ones in the banking industry. Like all other single measures, the P/E ratio shows only one aspect of an organization at a certain point in time, and should be used along with other information to make any investment decision.