Investment Strategy Quiz

Investment Strategy Quiz: What Is Your IU IQ?

by Alex Williams, Managing Editor, Investment U
Friday, June 15, 2007: Issue #684

We’ve covered a lot of ground in the past few weeks. Real estate, international equities, ETFs, the economy, practical techniques for managing your portfolio even where to put your cash for today’s best yields.

Today, let’s sharpen our retention skills with an investment strategy quiz

Below are five questions, reviewing some important ways to increase your total return. You can check your answers below.

Good luck!

A. Williams
Managing Editor, Investment U

What’s Your IU IQ?

1. Leadership qualities are tough to quantify. But at a company, what would a fundamental analyst claim to be one measure of management’s effectiveness?

A. An increase in stock-option compensation packages
B. A price-to-earnings ratio above 30
C. How many copies of The 7 Habits of Highly Effective People they’ve distributed to employees
D. Return on equity (ROE)

2. The Dow and the S&P 500 have made their way into uncharted territory of late. But should a bear market emerge, which of the following strategies would NOT reduce your risk profile?

A. Investing in less economically sensitive stocks, like utilities, food and drug companies, and defense contractors
B. Slightly increasing your margin balance
C. Closing out your call option positions
D. Spreading your risk among bonds, real estate investment trusts, gold shares, and inflation-adjusted Treasuries

3. Not all insider activity is created equal. But a strong indication of good times to come is:

A. A cluster of corporate executives accumulating shares at market prices
B. A company’s general counsel purchasing 10,000+ shares, at $0.00 per share
C. Systematic selling by the company’s CEO
D. Every member of the board unloading all of their shares

4. Anyone can buy a stock. The true art of investing is knowing when to sell it and, hopefully, for a profit. What’s the best way to know it’s time to cash out?

A. The price has doubled in less than a year
B. The broad market has corrected by more than 10%
C. Three or more analysts have downgraded the company
D. The stock falls below your designated trailing-stop price

5. Warren Buffett, John Templeton and Peter Lynch have all confessed that:

A. Stocks are inferior to cash, in the long term
B. You can’t beat the market for more than three years in a row
C. Stocks with higher price-to-earnings ratios are more “attractive”
D. There is no way of knowing what the market will due next

Bonus Question: What’s the easiest, safest and most cost effective way to own shares in the fastest-growing overseas markets? (Hint: two iShares ETFs.)

See the answers from today’s quiz below.

Investment Strategy Quiz Answers

(D) Return on Equity (ROE): A management team that has a history of increasing shareholder value will have a long track record of increasing dividend payments, buying back shares at reasonable prices, introducing new products But the more direct question is, how effectively are they using the company’s capital? ROE is one way of answering that question – measuring how much profit a company generates with the money shareholders have invested. Of course, a rising stock price is a pretty good indicator, too. More on leadership.

(B) Slightly increasing your margin balance. Clearly, in a bear market it’s best to reduce your margin balance, if not eliminate it entirely. Buying on margin, or borrowing from your broker against the cash/stock in your account, can leverage your losses as well as your gains. More on bear market strategies.

(A) A cluster of corporate executives accumulating shares at market prices. Officers sell their company stock for dozens of reasons, many of which may have nothing to do with the company’s financial health – divorce settlements, portfolio diversification, raising cash to buy a new home, etc. But when a handful of them start loading the boat, it’s one of the best leading indicators that business is looking up. Answer D, when every member of the board is unloading their shares, is a telltale sing of bad things to come. More on insider activity.

(D) Use a trailing stop. There are a number of theories about when to cash in your chips, but most of them are misguided. A trailing stop is simply a stop-loss order set a certain percentage below the market – and then adjusted as the price rises. Here’s an example.

(D) All the greatest investors – from Warren Buffett to Peter Lynch to John Templeton – confessed that they had no clue what the market was about to due next. Instead, they bought companies that were selling for a fraction of their true worth – and sold them when the market recognized that value. More on market timing and why it doesn’t work.

Bonus Answer: With international economies decoupling from the more sluggish U.S. economy – and the dollar grinding steadily lower – it’s a great time to plunk a good portion of your equity funds into foreign stock markets.

Here are two ETFs for anyone with little or no international exposure:

iShares MSCI EAFE Index (NYSE: EFA) for developed markets; and
iShares MSCI Emerging Markets Index (NYSE: EEM) for emerging markets.

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