Short answer: Investors look for stocks whose market price, the figure shown on the exchange, sits well below what the business appears to be worth based on its earnings, cash flow, assets and growth prospects. They compare price with these measures using ratios, then check whether the gap is real. No single ratio settles the question, and a stock that looks cheap on paper can stay cheap for a good reason.
Last reviewed: 7 November 2026
At a glance
| Term | What it compares | Low reading may suggest |
|---|---|---|
| Price-to-earnings (P/E) ratio | Market price against earnings per share | Undervaluation, when low against industry peers or the company’s own history |
| Price-to-book (P/B) ratio | Market capitalization against book value, the net worth recorded in the accounts | Assets, such as property, that the share price does not reflect |
| Price-to-free-cash-flow ratio | Market price against free cash flow, the cash left after necessary expenditures | Undervaluation |
| Market price versus fundamentals | Share price against the value judged from earnings, cash flow, assets and growth | Price below value, possibly only temporarily |
| Stock screener | A tool that filters companies by metrics such as P/E | Narrowed list of candidates for possible undervaluation |
Why do investors start with the P/E ratio?
The P/E ratio divides a stock’s market price by its earnings per share, which is the company’s profit divided by its number of shares. A low P/E relative to industry peers or the company’s own history may indicate undervaluation, because you are paying less for each rupee of profit.
Here is a hypothetical example, with all figures invented for illustration. Suppose a company, Example Ltd, has a share price of ₹200 and earnings per share of ₹20. Its P/E is 200 ÷ 20 = 10. If companies in the same industry trade at a P/E of around 20, also an invented figure, Example Ltd looks cheap, which is a reason to examine it further, not a conclusion.
The catch is that the P/E uses current earnings. A low P/E can appear when earnings are at a temporary peak, and the next year’s earnings may be lower, which would make the stock look less cheap than it first did.
What can the price-to-book ratio show that earnings cannot?
The P/B ratio compares a company’s market capitalization, the total market value of its shares, with its book value. Book value is the net worth the accounts record. A low P/B can reveal assets, such as property, that the share price does not reflect.
Using a hypothetical figure, suppose Example Ltd has a book value of ₹250 per share and a share price of ₹200. Its P/B is 200 ÷ 250 = 0.8, which means the market values the company below the net worth in its accounts.
The catch is that book value is an accounting figure. It may not match what the company’s assets would fetch if sold, and a company with weak earnings can have a low P/B for solid reasons.
Why look at free cash flow as well?
Free cash flow is the cash a company generates from operations after necessary expenditures, such as spending needed to keep its business running. A low price-to-free-cash-flow ratio may suggest undervaluation, because the market is paying less for each rupee of cash the business produces.
Hypothetically, if Example Ltd generates free cash flow of ₹25 per share and trades at ₹200, the ratio is 200 ÷ 25 = 8. Cash flow is harder to distort than some accounting profits, but it can still swing sharply from year to year, so a single year’s figure can mislead.
Where do undervalued prices come from?
Market price can lag behind real changes in fundamentals. Bad news or investor overreaction can also push prices below value temporarily. Both situations create the gaps that value investors look for.
The same mechanism creates risk. A falling price may reflect a real decline in the business rather than an overreaction, and in that case the stock is not cheap at all. Separating a temporary mispricing from a permanent problem is the hardest part of the work, and no ratio does it for you.
How do stock screeners help, and where do they fall short?
A stock screener lets you filter companies by metrics such as the P/E ratio, narrowing a large list to companies that meet your chosen conditions. This saves time and turns a broad search into a shorter list of candidates for possible undervaluation.
A screener only sorts numbers. If you filter for a low P/E alone, the list may include companies whose earnings are about to fall, or companies that are cheap for reasons the numbers do not show, such as weak management or pressure on their industry. Each name on a screened list still needs the fuller review described above.
What are the main risks of this approach?
The main risk is the value trap, a stock that looks cheap on several ratios but keeps falling because the business is deteriorating. Ratios are built from past or current figures, so they describe the company as it was reported, not as it will be. Reading the annual report, the trend in earnings and cash flow over several years, and the reasons behind any low valuation takes more effort than running a screen, and it still leaves uncertainty.
Frequently asked questions
Is a low P/E ratio enough to call a stock undervalued?
No. A low P/E relative to industry peers or the company’s own history may indicate undervaluation, but it is one input among several, such as price-to-book and price-to-free-cash-flow.
Can a cheap stock stay cheap for a long time?
Yes. Market price can lag behind real changes in fundamentals, and bad news or investor overreaction can push prices below value temporarily, so a gap can persist for a period before it closes or widens.
What does a stock screener do?
A stock screener lets investors filter companies by metrics such as the P/E ratio to narrow down candidates for possible undervaluation. It does not judge whether those candidates are actually undervalued.
Sources and last check
Facts in this article were checked against the sources below on 7 November 2026. Rules and figures can change; check the primary source before acting.
- groww.in (broker education)
- 5paisa.com (broker education)
- dhan.co (broker education)
- upstox.com (broker education)
This article is general information, not investment advice. MyFinanceBandhu is not a SEBI-registered investment adviser.