Last updated June 24, 2019
Earnings reports, mergers, and management changes. These developments that companies go through almost always give way to exaggeration of their stock price to some degree.
While harder to take advantage of and much less common, exaggeration may and will also occur on an aggregate market basis in the event of global developments such as trade wars. Although trading an index fund to take advantage of these occurrences would seldom prove profitable enough compared to individual stocks that have felt the shock most. Action should only be taken if the speculator has determined that the event that caused the depressed price is unfounded or likely to be resolved quickly with minimal damage, whether the new development affects the world economy or a specific company.
The mere fact that a large-cap company is a large-cap company creates a premium that investors have to pay for that company’s stock. The label ‘Large-Cap” comes with an understood notion that that company is a solid, well-built company with strong fundamentals.
Lack of interest. Obviously, this presumption is sometimes incorrect and the company may not live up to that notion and be priced irrationally rich even though the fundamentals may be horrific.
The income statement is a great example of oversimplification. The earnings of a company are not all just from their sales. It includes one-time revenue sources and returns from investments they made to name a few. The analyst would obviously value revenue from a fixed 10-year investment more than an inconsistent revenue source.
Companies that are being neglected by the larger public and exposure from editorial journals are more likely to be undervalued simply because they are lesser known and presumably have had less time under the microscope with analysts. These often small-cap stocks have greater potential becoming undervalued because they are often the stocks that are sold first in the event of a market downturn. Investor’s flight to safe and more predictable assets leave these stocks at irrationally low levels with no regard to their actual performance as a company. If you can stomach it, an investigation into these stocks during market corrections can have great potential in rewarding you with value propositions.