Stock market analysts warn of overvalued stocks all the time. When they say, "This stock is overvalued," what they really mean is it costs more than it's worth.
Here's a breakdown of what analysts mean when they say a stock is overvalued—and how you, as an investor, can use that information to your advantage.
Overvalued stock, explained
A stock becomes overvalued when its intrinsic value (aka true value) falls below its market value. Analysts come up with a stock's intrinsic value through methods like a discounted cash flow analysis, PE ratio, or asset-based valuation.
This value is usually a little different from its market value, or what its shares are currently worth in the market. However, when the market value is way above intrinsic value, analysts call out the stock for being overpriced.
What happens when a stock is overvalued? It's more likely to experience future volatility, which could mean capital losses for investors depending on their individual cost basis (or buying price). When an analyst suggests a stock may be overvalued, their opinion could be worth listening to.
Can an entire stock market be overvalued?
Individual companies, industries, and sectors of the stock market can be temporarily overvalued. Usually, an entire sector becoming overvalued means a bubble is preparing to burst.
In early Oct. 2021, shortly after the September sell-off, large-cap stocks in the US were 23 percent overvalued. This is an example of a bubble forming, even if it hasn't burst.
Examples of overvalued stocks in the wild
Tesla (NASDAQ:TSLA) whipsawed at the start of November with shares reaching an all-time high of $1,249.59 a pop. Volatility brought a two-percent decline the following day. Some experts say the stock is overvalued (like Jim Cramer, who said "I’ve actually never seen a stock go up endlessly on nothing") but others say it's right on par.
Netflix (NASDAQ:NFLX) also looks overvalued to some. This is because its forward earnings PE ratio (a way to determine intrinsic value) is more than double that of the S&P 500's.
How to determine if a stock is overvalued before buying
Investors should research any public company whose stock they plan to trade. Part of that research is finding out if it's overpriced. Here are some ways to look for overvaluation:
Look at the company's PE ratio (aka earnings forecast). Overvalued stocks tend to have stock prices that are more than 50 times the forecasted earnings.
In most cases, you can look at the price per earnings-to-growth (PEG) ratio and dividend-adjusted PEG ratio. These numbers can provide a true stock value that you can compare to the current price.
Consider what economic cycle the stock's country is currently in. If you're trading US stocks in the Middle East, for example, you'll want to consider the US economic cycle. If the economy is in a growth cycle, the stock may not be overvalued, just responding to the greater economic landscape.
FAQs
What Is "Overvalued"? An overvalued stock has a current price that is not justified by its earnings outlook, known as profit projections, or its price-earnings (P/E) ratio. Consequently, analysts and other economic experts expect the price to drop eventually.
Is it good to buy overvalued stocks? ›
Overvalued stocks are not necessarily good or bad. Although they will most likely see a correction in price, that doesn't always happen - and when it does, skilled investors can leverage that fact to secure gains.
Is it better to be overvalued or undervalued? ›
Generally, undervalued shares are favored over overvalued ones, as the investors buy low and sell high. If the company is performing well, it can give promising returns. Buying an overvalued share doesn't have this advantage, as the price returns to its intrinsic value, which is lower.
Does overvalued mean overpriced? ›
Stock market analysts warn of overvalued stocks all the time. When they say, "This stock is overvalued," what they really mean is it costs more than it's worth.
Is it good to buy undervalued stocks? ›
Investors with a long-term investment horizon may find undervalued stocks appealing, as they have the patience to wait for the market to recognise the stock's true value. By holding undervalued stocks over the long term, investors can benefit from potential price appreciation as the market corrects its mispricing.
Should you sell a stock when it's overvalued? ›
Overvalued stocks are ideal for investors looking to short a position. This entails selling shares to capitalize on an anticipated price declines.
Is Apple overvalued? ›
With its 3-star rating, we believe Apple's stock is fairly valued compared with our long-term fair value estimate of $160 per share. Our valuation implies a fiscal 2024 adjusted price/earnings multiple of 25 times, a fiscal 2024 enterprise value/sales multiple of 7 times, and a fiscal 2024 free cash flow yield of 4%.
How to tell if a stock is overpriced? ›
Price-earnings ratio (P/E)
A high P/E ratio could mean the stocks are overvalued. Therefore, it could be useful to compare competitor companies' P/E ratios to find out if the stocks you're looking to trade are overvalued. P/E ratio is calculated by dividing the market value per share by the earnings per share (EPS).
Is Tesla overvalued? ›
Contributor. Despite Tesla's TSLA -3.5% stock having lost more than 60% of its value since November 2021, recent analyst reports from JPMorgan indicate that the stock would have to drop by an additional 35% from its current level to reach fundamental value.
What is the most expensive stock right now? ›
US stocks with the highest price
| Symbol | Price | Sector |
|---|
| BRK.A D | 615900.00 USD | Finance |
| NVR D | 7416.32 USD | Consumer Durables |
| BKNG Common Stock D | 3795.35 USD | Consumer Services |
| SEB D | 3350.00 USD | Process Industries |
32 more rowsMost overvalued US stocks
| Symbol | RSI (14) | Price |
|---|
| GSL D | 92.65 | 28.64 USD |
| ONMD D | 90.97 | 2.30 USD |
| DAC D | 90.80 | 90.59 USD |
| LUCY D | 90.74 | 0.9830 USD |
29 more rowsValuation for Amazon
Morningstar analysts value Amazon using 3 times EV/sales, which I agree with. This leads to a fair value of $179.61 per share, which is currently just under 4% overvalued based on median revenue analyst estimates.
What is the Warren Buffett indicator? ›
The so-called Buffett indicator compares the total market capitalization (share prices times outstanding shares) of all U.S. stocks with the quarterly output of the U.S. economy.
Which stock will boom in 2024? ›
Best Stocks to Invest in India 2024
| S.No. | Top 5 Stocks | Industry/Sector |
|---|
| 1. | Tata Consultancy Services Ltd | IT - Software |
| 2. | Infosys Ltd | IT - Software |
| 3. | Hindustan Unilever Ltd | FMCG |
| 4. | Reliance Industries Ltd | Refineries |
1 more rowMay 6, 2024
If investors purchase overvalued stocks at inflated prices, they will likely experience significant losses when the price eventually corrects its intrinsic value. This can cause long-term damage to an investor's portfolio and retirement savings.
What stocks Bill Gates own? ›
Bill Gates Portfolio: 7 Best Stocks to Buy Now
| STOCK | % OF PORTFOLIO | MARKET VALUE OF SHARES |
|---|
| Microsoft Corp. (MSFT) | 33.5% | $15.4 billion |
| Waste Management Inc. (WM) | 16.4% | $7.5 billion |
| Berkshire Hathaway Inc. (BRK.B) | 15.9% | $7.3 billion |
| Canadian National Railway Co. (CNI) | 15.8% | $7.2 billion |
3 more rows4 days ago
Buying at the highs seems risky. The first question an investor should ask is if they are buying this stock as an investment, for the long-term, or a trade, for the short-term. What is the goal? Some will trade the chart, by using the 50 or 200-day moving averages or other technicals.
What should a company do if their stock is overvalued? ›
It is an unusual situation, but the best strategy for a company with an overvalued stock is to try to grow their way out of it, usually through mergers and acquisitions.
Should you short overvalued stocks? ›
“If a stock is overpriced, it's a good thing if short sellers can bring the price back down to its true value.”
