Subject 1. Estimated Value and Market Price

Equity valuation models are used to estimate the intrinsic value of an equity security. By comparing the intrinsic value and market price, an analyst can draw one of three conclusions: the security is undervalued, fairly valued, or overvalued. Investment decisions are then made based on the comparison.

There are two uncertainties in this process:

  • Which valuation model should we use?
  • Are the inputs to be used in the model appropriate?

Analysts often use more than one valuation model because of concerns about the applicability of any particular model and the variability in estimates that result from changes in inputs.

The model should be kept as simple as possible. The goal is to minimize the inaccuracy of the forecast.

There are three major categories of equity valuation models:

  • Present value models. Both dividend discount models and free-cash-flow-to-equity models belong to this category.
  • Multiplier models. These are relative valuation models.
  • Asset-based valuation models. These are based on the book value of assets and liabilities.

User Contributed Comments 5

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gill15: Heads up to people who are doing bonds next next chapter -- I already did them. Lot of people were asking tonnes of questions and were just confused all around when it came to the math. Either read the sections carefully OR just read the CFA curriculum books for those chapters.....the chapters are not long and you'll get near perfect on it and save yourself a tonne of confusion......If your good with bonds just do analyst notes...

I'm an actuary so it was easy. It's an easy section just know how to do stuff properly..Again this is to do with all the math parts of bonds
dmfz: Thank you for posting gill15
enetis: good color, thanks Gill
schweitzdm: Thanks for the heads up gill. I also read that CFAI overhauled the readings for fixed income level 1 this year. I suspect that due to this overhaul they might have a vitalized focus on the topic.
CFAToad: Thanks, Gill and Schweitz.