Undervaluation

Undervaluation is the condition in which the market price of an asset is believed to be lower than its intrinsic value or fundamental worth. In equity markets, an undervalued stock is thought to be priced below the present and future earnings capacity, assets, and growth prospects. In other markets, such as currencies or real estate, undervaluation describes prices that appear to depart from estimated fundamental levels.

Causes include information asymmetry, cognitive biases leading to underreaction or neglect, temporary supply-demand imbalances, and market frictions that slow adjustment. Undervaluation can also reflect discounted future cash flows, elevated risk premia, or expectations of mean reversion that markets have not yet incorporated.

Valuation approaches aim to estimate intrinsic value and compare it with market price. Common methods include discounted cash flow analysis, asset-based valuation, and relative multiples such as price-to-earnings or price-to-book. Currencies and real estate can be evaluated using purchasing power parity, price indicators, or rental yields. The degree of undervaluation depends on the accuracy of forecasts and the chosen discount rate or benchmark.

Investors may pursue undervalued assets through value investing, seeking capital gains when prices revert toward intrinsic value. However, undervaluation carries risks if fundamentals deteriorate or if the market remains irrational longer than expected. Real-world examples include temporarily depressed equities after negative headlines or currencies trading below long-run fundamentals due to policy interventions.