Advanced Diploma of Financial Planning (ADFP) Practice Test

What are value stocks characterized by?

1. High earnings and asset value

2. Low trading prices relative to historical earnings

3. Completely risk-free investments

4. High volatility

The correct answer is: Low trading prices relative to historical earnings

Value stocks are characterized by having low trading prices relative to their historical earnings. This characteristic suggests that these stocks may be undervalued by the market. Investors often look for value stocks with the premise that their intrinsic value is higher than the current market price, which could result in a potential for price appreciation. Additionally, these stocks typically have strong fundamentals, such as stable earnings and dividends, making them attractive to conservative investors looking for bargains. The focus on historical earnings indicates a belief that the company's past performance can offer insights into its future potential, leading to investment opportunities in companies that may be overlooked or mispriced in the market. The other options describe characteristics that do not align with the typical attributes of value stocks. High earnings and asset value, while beneficial, do not specifically define a value stock. The notion of completely risk-free investments contradicts the fundamental nature of stock investments, which always carry some level of risk. Lastly, high volatility generally characterizes growth stocks or stocks in frenetic market sectors, rather than value stocks which are often perceived as more stable.