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CFA® Level I · Equities · free lesson
Introduction to Equity Valuation
Equity analysis exists because the price of a share and its value are not the same thing. This module explains how analysts think about intrinsic value relative to market price, what book value, market capitalization and enterprise value do and do not tell you, and how the main families of valuation models compare, setting up the detailed models in the modules that follow.
What you will learn
1. Distinguish between the market price of a share and its intrinsic value, and explain how an analyst uses a value estimate to judge whether a share is mispriced.
- Price is observed; intrinsic value is an analyst's estimate based on expected cash flows and risk.
- Value > price suggests undervaluation; value < price suggests overvaluation.
- Act on a gap only if confident in the estimate and if price is likely to converge to value.
- A large gap should first prompt a check of the analyst's own assumptions.
- Going-concern value usually exceeds liquidation value; investment value is buyer-specific.
2. Contrast book value of equity, market capitalization and enterprise value as indicators of a company's intrinsic value.
- Book value is a historical-cost accounting measure that omits most internally created intangibles.
- Book value is most useful for financial firms; least useful for asset-light firms.
- Market capitalization = price x shares outstanding, the market's forward-looking equity value.
- EV = market cap + debt + preferred + non-controlling interests - cash and short-term investments.
- EV values the operating business for all capital providers and is capital-structure neutral.
3. Describe the main categories of equity valuation models and explain the advantages and disadvantages of each.
- Present value models: DDM, FCFE, FCFF and residual income, each discounting a different measure.
- Multiplier models: price multiples and EV multiples applied to comparables or justified fundamentals.
- Asset-based models: fair value of assets minus liabilities.
- PV models are theoretically sound but very sensitive to discount and growth rates.
- Choose the model to fit the company: payout policy, cash flows, asset type and peer availability.
Module at a glance
- Price is observed; intrinsic value is estimated. Undervalued: value > price; overvalued: value < price.
- Act on mispricing only with confidence in the estimate and a reason to expect convergence.
- Book value is historical and omits most internal intangibles; it is most useful for financial firms.
- Market cap = price x shares; EV = market cap + debt + preferred + NCI - cash.
- Valuation families: present value (DDM, FCFE, FCFF, residual income), multiples, and asset-based.
- Pick the model that fits the company's payouts, cash flows and assets, then cross-check.
This free module has 3 lessons, 11 practice questions with full explanations.