Every investor dreams of finding stocks that rise and deliver solid returns. Undervalued stocks often go unnoticed, priced lower than their real worth due to market overreactions or temporary issues. But history shows they tend to outperform over time. They offer a safer entry point, stronger potential for gains, and room to grow as the market catches up. Smart investors know value always finds its way back.
In this article, we’ll discuss why undervalued stocks usually outperform and how you can spot them.
Outperformance Secrets of Undervalued Shares
Here’s why undervalued stocks tend to deliver superior returns:
1. Value Premium Exists in Indian Markets
In India, “value premium” means that stocks priced cheaply compared to their earnings or book value tend to earn better returns than expensive ones.
Studies from 1999 to 2015 show that portfolios of undervalued stocks with low P/E, P/B, or high dividend yield consistently beat both growth stocks and broader market averages, even after adjusting for risk.
One study using earnings to price (E/P) ratios in Indian IT stocks showed undervalued firms earned noticeably higher profits, year after year, compared to overvalued ones. In short, buying good stocks when they’re cheap works well in India.
2. Market Inefficiencies & Behavioral Biases
Markets aren’t always rational. Investors often overreact or underreact to news, buying too enthusiastically when things look good and panicking when they don’t. This herd behavior pushes prices away from a company’s real value.
Emotions like fear (loss aversion) or overconfidence can distort judgment. Some firms get overlooked (the “neglected firm” effect), meaning savvy investors can find undervalued gems. These biases and uneven information flow create mispriced stocks.
Value-seeking investors exploit these inefficiencies by buying low and waiting for prices to correct, earning returns above the market average.
3. Margin of Safety & Lower Downside Risk
Buying a stock with a margin of safety means paying significantly less than its estimated true value, giving you a cushion if things go wrong.
For example, if a stock’s intrinsic value is ₹1,000 but you buy it at ₹800, you’ve built in a 20% buffer. This protects your investment from mistakes or market swings.
4. Factor Investing & Value Factor
Factor investing is an approach where you choose stocks based on certain traits like value, momentum, or quality that research shows often outperform the market.
The value factor specifically targets stocks priced lower than their true worth, using metrics like low P/E or P/B ratios. The idea is that the market sometimes underprices good companies, and by buying cheap and holding on, you benefit when their prices recover.
Value is one of the most studied and reliable factors across global and Indian markets.
5. Long-Term Mean Reversion
Long‑term mean reversion means that over many years, a stock, say, Bajaj holding share price tends to move back toward its historical average. This happens because:
- Prices often swing too high or too low due to emotions, news, or short-term events.
- But fundamentals (like earnings or cash flow) don’t change as drastically overnight. So over time, the market corrects itself.
- In India, studies show stock returns tend to revert, meaning big drops or spikes are often followed by a reversal.
In simple terms: if a stock shoots up or plunges unfairly, it’s likely to settle back toward its usual value over time.
Conclusion
Undervalued stocks often do better because they are bought at a low price and have strong business potential. In India, this works well due to market inefficiencies and long-term growth. By focusing on good fundamentals and staying patient, you can benefit when the market finally realizes the stock’s true worth and the price goes up.
