Why Are So Many Stocks "Overvalued"?

An overview of why many stocks give an overvalued result

May 04, 2021

If you're new to the site and have started looking through companies, you may be wondering why so many look similar to this:

An overvalued analysis result

Results like this may give the impression that the site is broken or DCF models are highly inaccurate. Let's provide some background to why so many companies currently give these results.

Two major factors:

  1. Current stock market conditions
  2. Type of company (ex. growth)

Overall Stock Market Conditions

The market is at or near it's all time highs for the entire history of the stock market. This makes it incredibly difficult to find undervalued companies: on average, everything is priced high.

As an example, historical P/E (Price to Earnings) Ratio of the entire market looks like this:

Historical P/E ratio

Source: https://www.multpl.com/shiller-pe

P/E ratio is the price of a company versus the earnings it creates. It can be thought of as the price someone is currently willing to pay for the earnings a company provides. As you can see, this ratio is higher than nearly any moment in history. Simply put, investors are paying historically high for these earnings, which drives stock prices up and eliminates many "undervalued" opportunities.

Understanding market conditions, undervalued companies will come from two main scenarios. The whole market can sell-off, driving prices lower and eventually below their intrinsic value. Or earnings can beat expectations driving cash flows higher, increasing intrinsic value above the stock price. Both of which create "undervalued" opportunities.

With these conditions, investors must search harder to find undervalued companies currently.

Growth Stocks

There is a growing popularity for growth stocks, with much hype and anticipation surrounding them. It's not uncommon to see high growth stocks with expected increases of 80% or more year over year, that may not be profitable right now.

These companies certainly have value based on these expectations to a growth investor, but not necessarily as much as from a value perspective. Discounted Cash Flow (DCF) models are inherently value focused, best applied to proven companies with established revenue streams and are profitable. Looking at cash flows in a growth company that may have no revenue isn't very useful: unless the company has positive flows, a DCF model will come up with $0 value.

With DCF Tool, you can account for this by adjusting the growth rate and next year's cash flow accordingly. Because growth companies rapidly evolve, using the growth rate DCF Tool calculates and historical cash flows don't give a full picture of future performance. Instead of using historical performance, you can adjust based on company forecasts to account for their high growth expectations. Keep in mind that as these inputs are adjusted, the model becomes much more dependent and therefore sensitive to these assumptions- slight differences can vastly affect the accuracy.

Using DCF Tool

DCF Tool provides investors with the quickest and easiest tool at creating a DCF model. No matter the market, DCF Tool can assist in quickly analyzing a company's intrinsic value to find undervalued gems.