Can you correctly define value investing and how it relates to your portfolio? Here’s a quiz to see if you can.

It’s important to be able to properly define value investing before making your stock picks. In turn, and in our view, your goal as an investor, particularly if you follow a conservative investing strategy based on our philosophy, is to make an attractive return on your investments over a period of years or decades. Failure means making bad investments that leave you with meagre profits, or losses.

Do you know how to define value investing? Test your knowledge below.

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A. What qualities do value stocks have in common?

1. Value stocks trade lower than their fundamentals suggest
2. Value stocks have a strong potential to rise
3. Value stocks often have hidden assets
4. All of the above

You are correct if you answered 4.

A value stock is a stock that is reasonably priced, if not cheap, in relation to its sales, earnings or assets. Investors hold onto the best value stocks because they expect that other investors will in time recognize their value and push up their share prices. High-quality value stocks like these are difficult to find, even when the markets are down. But when you know what stocks to look for, you can uncover them.

Hidden assets are valuable assets that investors often overlook, discount or disregard altogether. They can be found in real estate on the books at historical prices, in research spending, in well-known brand names and so on.

B. Good value stocks to invest in have what historical properties?

1. A well-financed company
2. A history of returns and dividends
3. Freedom from business cycles
4. All of the above

You are correct if you answered 4.

At the core of the Successful Investor approach to strong value investing returns is identifying well-financed companies that are established in their businesses and have a history of earnings and dividends. They are likely to survive any economic setback that comes along, and thrive anew when prosperity returns, as it inevitably does. Value investors have long-term mindsets when it comes to investing.

C. Some of the basic ratios investors use to look for value stocks include…

1. Price-to-earnings ratio
2. Price-to-book-value ratio
3. Dividend yield
4. All of the above

You are correct if you answered 4.

Many successful investors have some knowledge of technical analysis, and most have some knowledge of a variety of other tools and shortcuts. But almost all successful investors take a broad view, and apply everything they know to their investing decisions.

When you look for stocks that are undervalued, it’s best to focus on shares of quality companies that have a consistent history of sales and earnings, as well as a strong hold on a growing clientele. Furthermore, we recommend using a few basic ratios.

• Low price-to-earnings ratios may be signs of cheap or undervalued investments.
• Low price-to-book-value ratio is another sign that a stock is cheap in relation to other stocks on the market.
• Dividend yield is the stock’s annual dividend divided by the share price. A high dividend yield could indicate a cheap stock that is set to rise.

D. True or False: Value investing should be used over growth investing.

You are correct if you answered “False.”

If you meet a large number of investors over a large number of years, it may seem they come in two basic categories—one inclined toward value investing, the other more interested in growth.

But together, growth stocks and value stocks can form a winning combination. A growth stock can be a top performer while the company is growing. However, a single quarter of bad earnings can send it into a deep, though often temporary, slide. Value stocks can test your patience by moving sluggishly for months, if not years. But they can make up for it by rising sharply when investors discover their true value.

 E. Investors need to watch out for “false” value. Some indicators of that are…

1. An unusually high dividend yield
2. An unusually low P/E ratio
3. An exceptionally low ratio of stock price-to-book value
4. All of the above

You are correct if you answered 4.

Some of the measures that mislead you into buying the wrong value stocks are statistical. They include unusually high dividend yields, unusually low per-share price-to-earnings, or P/E ratios, and a low ratio of a stock’s price-to-book value or other measures of per share value.

Any of these measures can make it seem like a stock is a bargain. But in fact, any of them can simply be due to a low stock price that is the result of selling by well-informed investors who recognize a dismal long-term future.

Another way to fall into this trap is to put too much faith in the value of a brand name. A strong brand can sell a lot of a strong product, or keep an over-the-hill product going long after competitors have faded. But even the strongest brand name can only do so much.

Follow our three-part Successful Investor approach when buying value stocks—or any stocks for that matter—to make the best picks

1. Hold mostly high-quality, dividend-paying stocks.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
3. Downplay or stay out of stocks in the broker/media limelight.

Many value investors are turning away from a focus on value and going towards growth stocks. What are your thoughts on this move?

What is the biggest difficulty you’ve come across with value investing?