How to quickly spot undervalued stocks

Readers who have kept tabs with my posts on stocks and stock analysis tools may be aware that I focus on stock selection and don’t beat around the bush with fancy quotes.  In keeping with that spirit, here is a simple way to quickly spot undervalued stocks using Morningstar’s Quantitative Equity Ratings. This post is meant for new stock investors and not experts who like to find fault with everything.

I strongly believe investors who wish to try direct equity must do three things: A: Quicky start investing in solid companies. This will help: How new stock investors can quickly start investing using NIFTY Multi-Factor Indices.Learn how to value a stock in multiple ways. This free tool would help with that: Automated Earnings Power Stock Analysis With data and this: 50 stocks with solid earnings power: Ability to self-fund and create value C Always keep track of the annualized returns of each stock and your entire portfolio. Preferably create a dummy mutual fund portfolio and invest the same amount (imaginary) that do in stocks in an index fund (nifty next 50) and an active mutual fund of your choice. If after 3-5Y, you cannot beat the index or the active fund, it is better to evaluate if you should spend time on direct equity investing (unless you want to do it for fun and education). This will help to find returns: How to calculate annualized return (XIRR) from a stock investment

Before we proceed, it is important to recognise that no valuation method is perfect and the following requires you to trust  Morningstar’s Quantitative Equity Ratings as the exact formulations are unknown. I have included as much information as I could find the necessary links. Also, not everyone will agree on what stock to buy or sell. So unless you have conviction and courage, you cannot get started.

How to find undervalued stocks?

1. Head over to Morningstar Equity tools. You will find this screen.

2: Click on undervalued stocks and it will open up this list

So now you have a list of 2065 undervalued stocks to choose from! Obviously, that is a bit too much and has to be reduced. This is where MorningStars other metrics come in. Before we proceed let us look at all four of them.

Quantitative Valuation

This is a ratio of the fair value estimated with discounted cash flows (DCF) and its current market price.  The rating is expressed as Overvalued, Fairly Valued, and Undervalued. It is not known how this rating is derived but the valuation method is well known: Automated Stock Analyzer with Discounted Cash Flow Valuation (this is a older version explaining the DCF). The main problem with any valuation method is the analyst inputs. These are crucial to the result and is based on a qualitative perception of risk and reward in a particular industry. So it will be arbitrary.

Quantitative Economic Moat

A moat is hole surrounding a castle to prevent attacks. Wider the moat, safer the castle. Warren Buffett used this term to identify the competition a particular company has in a sector. According to Morningstar,

We assign one of three Morningstar® Economic Moat™ Ratings: none, narrow, or wide. There are two major requirements for firms to earn either a narrow or wide rating: 1. The prospect of earning above-average returns on capital; and 2. Some competitive edge that prevents these returns from quickly eroding.

Quantitative Financial Health

This is a measure of how well a company will meet its financial obligations and is expressed as Weak, Moderate, and Strong.

Quantitative Uncertainty

This takes into account future possible outcomes of the companies share price. It is possible for it to fluctuate wildly due to its proposed activities and how they will be received? Or will it be stable as it is a well-established player?  The rating is expressed as Low, Medium, High, Very High, and Extreme. A low rating implies a more stable return (possibly low) and higher rating implies higher risk-reward and requires a greater margin of safety in valuation.

3: Now let us head back to our screener and demand the following:

Wide-Moat + Undervalued stock + low uncertainty + Strong Financial Health

Result: No stocks found. This is to be expected as we cannot demand too much! So now let us relax these constraints in different ways.

Wide-Moat + All valuations + low uncertainty + Strong Financial Health

Result: Three Stocks

Those are some solid companies to buy. Remember good companies will not become undervalued often. So if you don’t mind the price of entry and recognise that the reward will be decent from such companies if given enough time, you can consider these.

4: Wide-Moat + All valuations + medium uncertainty + Strong Financial Health

Result: Colgate, Dabur, HUL, Pidilite. Again, solid picks if you don’t mind the price.

5: Wide-Moat + All valuations + medium uncertainty + moderate Financial Health

Result: Avenue Supermarts Ltd I know nothing about this. So no comment.

6: Wide-Moat + Undervalued + high uncertainty + strong Financial Health

Result: Cummings India, Siemens. That does not look terrible does it?

7:  Narrow-Moat + Undervalued + medium uncertainty + strong Financial Health

Result: ACC, Ambuja, Wipro. Again decent?

You can keep playing with this all day to cough up multiple possibilities. The idea is to recognize the risks as you change the screening criteria. The point of this post is that you can quickly spot undervalued stocks, screen them further in terms of moat and financial health. The uncertainty gives you an estimate of future risk.

Depending on your confidence and comfort level, you can either buy or dig deeper. But always remember to visit the individual stocks MorningStar page (Avenue Supermart is linked above).  Please also do not fail to read the MorningStar reference documents linked below. Good luck. As always I would like to know what you think. If you have similar or better resources to quickly screen for stocks, let me know.

Reference Documents

Guide to Morningstar’s Equity Research Methodology

Morningstar Quantitative Equity Ratings Fact sheet

Did you download this book?

Click the image to download

Do share if you found this useful

Create a "from start to finish" financial plan with this unique open-source robo advisory software template

 Don't like ads but want to support the site? Subscribe to the ad-free newsletter! 
You will get the full post-ad-free delivered to your inbox for Rs. 3000 a year. Follow this link to read the terms and sign up! 

About the Author M Pattabiraman author of freefincal.comM. Pattabiraman is the co-author of two books: You can be rich too with goal based investing and Gamechanger. “Pattu” as he is popularly known, publishes unbiased, promotion-free research, analysis and holistic money management advice. Freefincal serves more than one million readers a year with numbers based analysis on topical issues and has more than a 100 free calculators on different aspects of insurance and investment analysis, including a robo advisory template for use by beginners. Contact information: freefincal {at} Gmail {dot} com He conducts free money management sessions for corporates (see details below). Previous engagements include World Bank, RBI, BHEL, Asian Paints.

Content Policy

Freefincal has original unbiased, conflict-of-interest-free,  topical reports, reviews, commentary and analysis on all aspects of personal finance like mutual funds, stocks, insurance etc. All guest authors and contributors to the site also do not have any conflict of interest. If you find the content useful, please consider supporting us by (1) sharing our articles and (2) disabling ad-blockers for our site if you are using one. No promotional content We do not accept sponsored posts and link exchange requests from content writers and agencies. This is our privacy policy Our website is non-profit in nature. The revenue from the advertisement will only be used for hosting charges, domain registration charges, specific plugins necessary for traffic growth and analytics services for search engine optimisation.
Want to conduct a sales-free "basics of money management" session in your office?
I conduct free seminars to employees or societies. Only the very basics and getting-started steps are discussed (no scary math):For example: How to define financial goals, how to save tax with a clear goal in mind; How to use a credit card for maximum benefit; When to buy a house; How to start investing; where to invest; how to invest for and after retirement etc. depending on the audience. If you are interested, you can contact me: freefincal [at] Gmail [dot] com. I can do the talk via conferencing software, so there is no cost for your company. If you want me to travel, you need to cover my airfare (I live in Chennai)

Connect with us on social media

Do check out my books

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingMy first book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.  It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You WantGamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantMy second book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

The ultimate guide to travel by Pranav Surya

Travel-Training-Kit-Cover This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step.  Get the pdf for ₹199 (instant download)

Free Apps for your Android Phone

All calculators from our book, “You can be Rich Too” are now available on Google Play!
Install Financial Freedom App! (Google Play Store)
Install Freefincal Retirement Planner App! (Google Play Store)
Find out if you have enough to say "FU" to your employer (Google Play Store)

Blog Comment Policy

Your thoughts are vital to the health of this blog and are the driving force behind the analysis and calculators that you see here. We welcome criticism and differing opinions. I will do my very best to respond to all comments asap. Please do not include hyperlinks or email ids in the comment body. Such comments will be moderated and I reserve the right to delete the entire comment or remove the links before approving them.
Updated: May 27, 2018 — 12:28 pm


Add a Comment
  1. is another tool

    1. Does it have a readymade undervalued vs overvalued listing?

Leave a Reply

Your email address will not be published. Required fields are marked *