What Is "Overvalued"?

An overvalued stock has a current price that is not justified by its earnings outlook, known as profit projections, or its 澳洲幸运5官方开奖结果体彩网:price-earnings (P/E) ratio. Consequently, analysts and other ecꩵonomic experts expect the price&n🥂bsp;to drop eventually.

Overvaluation may result from an uptick in emotional trading, or illogical, gut-driven decision making that artificially inflates the stock's 澳洲幸运5官方开奖结果体彩网:market price. Overvaluation can also occur due to deterioration in a company's fundamentals and financial strength. Potential investors strive to avoid ov🦂erpaying for stocks.

Understanding Overvalued Stocks

A small group of market theorists believes that the market is perfectly efficient, by nature. They opine that 澳洲幸运5官方开奖结果体彩网:fundamental analysis of a stock is a pointless exercise because the stock market is all-knowing. Therefore, sto🐭cks may neither be truly undervalued 𝕴or overvalued. Contrarily, fundamental analysts are staunch in their belief that there are always opportunities to ferret out undervalued and overvalued stocks because the market is as irrational as its participants.

Overvalued stocks are ideal for investors looking to 澳洲幸运5官方开奖结果体彩网:short a position. This entails selling shares to capitalize on an anticipated price declines. Investors may also legitimately trade overvalued stocks at ⭕a premium due to the brand, superi꧟or management, or other factors that increase the value of one company's earnings over another.

How to Find Overvalued Stocks

Relative earnings analysis is the most common way to identify an overvalued stock. This metric compares earnings to some comparable market value, such as price. The most popular comparison is the 澳洲幸运5官方开奖结果体彩网:P/E ratio, which ꩲanalyzes a company's stock pr🍎ice relative to its earnings.

Analysts looking for stocks to short may seek overvalued companies with high P/E ratios, particularly when compared to other companies in the same sector or 澳洲幸运5官方开奖结果体彩网:peer group. For example, assume a company has a stock price of $100 and 澳洲幸运5官方开奖结果体彩网:earnings per share of $2. The calculation of its P/E ratio is determined by dividing the price by the earnings ($100/$2 = 50). So, in this example, the se🍌curity is trading at 50 times earnings.

If that same company has a banner year and makes $10 in EPS, the new P/E ratio is $100 divided by $10, or 10 times ($100/$10 = 10). Most people would consider the company to be overvalued at a P/E of 50, but possibly undervalued at 10.

Real World Example

Although by definition, a stock is overvalued only by the opinion 🌞of an analyst, The Motley Fool website is never shy about weighing in. For exaꦯmple, they deemed the pharma giant to be overvalued because the company's valuation reached "untenable levels following the company's meteoric rise during the tail end of 2019 and early days of 2020."

According to The Motley Fool, in January 2020, the company's stock was the second most expensive among its industry peers and Eli Lilly might find it hard to deliver consistent expected growth.