Cheap Stocks: What They Are, And How To Invest - NerdWallet (2024)

Stocks are coming off a bumpy year. The S&P 500 fell by about 20% over the course of 2022.

That might sound like bad news for investors, but it's very good news for bargain-hunters.

When the markets get rocky, some investors get frustrated — but others get excited for the chance to buy cheap stocks. If you fall into the latter category, here's what you need to know.

What is a cheap stock?

One way to describe inexpensive or cheap stocks is with the term "undervalued." For example, an undervalued company may have strong fundamentals in place, but perhaps the market hasn't yet caught on, and the current price of the stock doesn't accurately reflect the true, potentially higher value of the company. (This dovetails with the investing strategies surrounding value and growth stocks.)

In other words, undervalued stocks offer good value for the money, not just a low share price.

There’s a quick way to begin searching for these stocks, and it’s available at many brokerages: a stock screener. It’ll help you sort stocks by any criteria that you think are important, so you can focus on the most likely candidates for further research.

How to find cheap stocks

Investing in individual stocks requires a lot of work, and finding candidates is just the start of the process. You’ll also need to:

That’s just the minimum that you need to do. So if this isn’t how you want to spend your evenings and weekends, consider buying an index fund instead. Put money in it regularly and go have fun.

However, if you want to make individual stocks a potentially lucrative hobby, here’s your guide.

1. Choose a stock screener

The screener allows you to sort by almost any characteristic you can imagine. You can input traits that you want your results to have, such as annual sales growth above a certain level, say 10%.

Growth rates and value are relatively basic criteria, so the example in this article will screen for stocks on these dimensions. Better screeners will offer more criteria and more customization.

2. Set a target for future earnings growth rate

You can define good companies in many ways, but a typical method is to look at how fast the company is growing. Quick-growing companies tend to be valued more highly by investors, so they’re an attractive place to begin your search for good companies.

On the screener, sort stocks by their future earnings growth rate. A good place to start may be around 10% annually over the next five years; then, try increasing this to 15% or even 20% to see what's available. Earnings growth above 20% is very high.

If the screener doesn’t display future earnings growth, then sort by sales growth. Again, search for companies growing sales (also called revenue) at your preferred growth rate. And if the screener doesn’t have future earnings projections, look in the rearview mirror: find earnings or sales growth for the past five years instead.

3. Use the P/E ratio to find potentially undervalued stocks

Now that you have a list of fast-growing companies, you can add an additional consideration: price.

You'll want to look for inexpensive companies, meaning undervalued stocks and not just stocks with a low share price. There are plenty of stocks that offer a low share price, but in many cases, you may be getting what you paid for.

To evaluate a stock’s value, investors will often divide the current price of one of its shares by its annual earnings per share. The resulting number is called the price-earnings ratio, or P/E ratio.

The lower the P/E, the cheaper the company is. For example, investors might be willing to buy Meta stock at a P/E of 15 this year, while they paid a P/E of 30 last year.

Most screeners can display companies' current P/E ratios so you can compare them alongside other factors.

4. Focus on market cap to screen out risky companies

At this point, you should be left with dozens of companies that are relatively cheap and that financial analysts think will grow earnings well in the future.

If you end up with more companies than you need, set the minimum size of the company, as measured by its market capitalization, to avoid some of the smaller, riskier stocks. In general, the smaller the market cap, the riskier the company. Large caps, on the other hand, are companies valued over $10 billion.

If your list is still too long, consider adding a few more criteria:

5. Research the stocks

Now, with your narrowed list, it's time to research the stocks. For each you consider, you’ll want to figure out:

Answering these fundamental questions is a big task, especially if you’re aiming to have a well-diversified portfolio. Plus, after you’ve purchased your stocks, you’ll want to keep up with the companies by analyzing at least the quarterly earnings reports.

If you’re looking to dig into investing in stocks, open an account with a broker that provides good screening and research, including the work of professional analysts that can help you get started.

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