Advanced Diploma of Financial Planning (ADFP) Practice Test

What distinguishes value stocks in the market?

1. They are known for their high volatility

2. They are undervalued based on fundamentals

3. They typically share high dividend yield

4. They are generally issued by small companies

The correct answer is: They are undervalued based on fundamentals

Value stocks are characterized by being undervalued based on their fundamental financial metrics. This means that the market price of these stocks is lower than their intrinsic value, usually determined by factors such as earnings, sales, and overall growth prospects. Investors often seek value stocks with the expectation that the market will eventually recognize their true worth, leading to price appreciation over time. The concept of value investing is typically associated with established companies that may be experiencing temporary challenges or are overshadowed by larger growth stocks. These companies often have stable earnings, lower price-to-earnings ratios, and solid asset bases, indicating that they may be good investment opportunities at their current prices. While value stocks may also possess other characteristics, such as a high dividend yield, this is not a definitive feature that distinguishes them from other types of stocks. They can be part of various company sizes, and their volatility can vary significantly. Overall, the key distinguishing factor of value stocks is their valuation relative to their fundamentals, which is why the option focusing on undervaluation is the correct choice in this context.