Nigeria’s stock market is in a stormy phase this November. In just a few weeks, investors have watched the NGX lose trillions in market value as panic-driven selloffs sweep through equities.
The trigger? Fear and uncertainty, not weak fundamentals.
At the heart of this selloff are two major concerns: the proposed 30% capital gains tax on profits above N150 million (expected in 2026), and geopolitical jitters following recent global tensions.
Yet, beneath the noise, most listed companies are still reporting strong earnings, solid balance sheets, and healthy cash flows.
That disconnect between performance and perception is exactly where opportunities often hide.
When market prices fall faster than the company’s fundamentals, value investors start to see potential bargains.
In other words, the current bearish trend might just be creating a shopping window for discerning investors.
This makes this discussion very important, identifying stocks that are still undervalued despite the market trend.
What is an undervalued stock?
An undervalued stock is one whose market price is lower than its intrinsic value; that is, it’s real worth based on fundamentals such as earnings, assets, and future growth potential.
Think of it this way: if, for example, Okomu Oil’s shares trade at N1,110 on the NGX, but analysis shows the shares are worth N1,200 per share, then they are undervalued by N90 with upside potential of 8.11%.
How to find undervalued stocks
To find undervalued stocks, you need to assess their “true worth” and compare them to their market price.
For example, let’s still adopt our Okomu’s stock intrinsic value example of N1,200 per share. But how is this calculated?
The intrinsic value can be estimated using several methods:
- Dividend Discount Model: Estimates the stock value based on expected dividends over time.
- Discounted Cash Flow: Projects future profits (cash flows) and calculates their present value.
- Earnings Multiples: Compares a company’s earnings to its peers or industry average to assess if the stock is priced fairly.
While DDM and DCF require deeper financial knowledge, retail investors can use simpler tools like the P/E ratio to identify undervalued stocks based on earnings.
The P/E ratio:
The P/E ratio shows how much investors are willing to pay for every N1 of a company’s earnings.
It is calculated by dividing the share price by earnings per share (EPS).
- Share price is the market price of the stock you see quoted on the exchange.
- Earnings per share (EPS) can be calculated by dividing a company’s net profit by the weighted average number of shares outstanding for the period.
It’s important to note that EPS (TTM) is usually used when calculating the P/E ratio.
- TTM (Trailing Twelve Months) EPS refers to the EPS for the most recent four quarters, rather than just a single period or year.
This method captures a more comprehensive view of a company’s earnings, ensuring that the calculation reflects the most up-to-date performance.
For example, assuming Zenith Bank’s TTM EPS is N25.15 and its current share price is N54, the P/E ratio would be 2.15x (N54/25.15)
- This means that for every N1 of earnings Zenith Bank generates, investors are willing to pay N2.15 for the stock.
A lower P/E ratio like that of Zenith Bank may suggest that a stock is undervalued, particularly when compared to:
- Industry or sector averages,
- Historical averages, or
- The broader market average.
Now, let’s look at the average P/E ratio of the 12 listed banks. The average P/E for these banks, including Zenith Bank, is 2.82×.
With Zenith Bank’s ratio below the average, it could indicate that investors are not fully appreciating Zenith Bank’s earnings potential, possibly due to broader market sentiment or temporary factors such as market concerns.
However, it’s important to note that a low P/E ratio doesn’t always indicate a good deal. It could also signal deeper issues, such as:
- Slowing growth,
- Regulatory headwinds, or
- Poor asset quality.
But in the case of Zenith Bank, this caveat may not apply. Zenith is one of the most profitable banks in the sector, suggesting that its low P/E may not reflect an underlying problem, but rather a temporary market reaction or broader sentiment affecting the entire sector.
For instance, the NGX banking sector has lost more than N1.6 trillion in market capitalisation in November alone, with bank share prices falling by over 9%, despite strong earnings performance.
This could suggest that a market concern or uncertainty is driving the bearish trend, and as such, Zenith Bank may indeed be undervalued.
Given the current market conditions, it might be a good time to buy, as the stock is priced lower relative to its peers
Using P/E in conjunction with other ratios
However, the P/E ratio should not be used in isolation. It is most effective when considered alongside other earnings multiples and valuation metrics, such as:
- Price-to-Book (P/B) ratio,
- Price-to-Sales (P/S) ratio, and
- Price-to-Earnings Growth (PEG) ratio.
In fact, the average P/B ratio and P/S ratio for the sector stand at 0.93 and 0.70, respectively.
For Zenith Bank, the P/B ratio is 0.61, and the P/S ratio is 0.59, below the sector averages, further suggesting undervaluation.
These ratios, in combination with the P/E, provide a fuller picture of the stock’s true value.
Analysts’ valuations and recommendations
Another effective and fast method for finding undervalued stocks is by following analysts’ valuations and stock recommendations.
For retail investors, calculating intrinsic or relative value can be complex and time-consuming. Fortunately, you don’t have to do all the heavy lifting yourself. Instead, you can leverage stock recommendations and valuations provided by market analysts.
Sites like Nairametrics’ Follow the Money (https://ftm.ng) offer regular stock recommendations based on detailed analysis and industry expertise. There are also other sites or recommendations from your stockbrokers or financial advisers. Stock trading is a very big business, and it would not harm you to have advice at a reasonable cost.
This helps you have a curated list of undervalued stocks, saving you time and effort in your search for potential buying opportunities.
Stock screening
Stock screening is a powerful tool that helps retail investors identify potentially undervalued stocks by filtering them through specific metrics and benchmark criteria.
Platforms like Nairametrics, Bloomberg, stockbroking companies’ online trading platforms, and Yahoo Finance offer tools that Nigerian investors can use to filter stocks based on these metrics, helping identify opportunities amidst the volatility and market trends unique to Nigeria. Look out for certain metrics:
- Dividend Yield: Look for stocks offering a high dividend yield, indicating strong cash flow and consistent income generation. You can set your target, say, above 8%
- Return on Equity (ROE): Screen for companies with an ROE above 15%. A ROE above 20% is generally considered excellent.
- Debt-to-Equity Ratio (D/E): Look for companies with a low D/E ratio (generally below 1), indicating less reliance on debt and a more stable financial position
These benchmarks, though not limited to these three, can help retail investors screen stocks that align with their investment strategy while focusing on financial health and growth potential. Let me know if you’d like to refine any further details or add other metrics!
