CFA® Equity Valuation
Equity investments, that is, stocks, are probably the most familiar asset to investors worldwide. Whether public or private, equity capitalizes every business endeavor and is ubiquitous in investor portfolios. The nature and valuation of equity, along with equity markets, investments, and investors, are explored in this CFA topic area. As it progresses toward L3, equity valuation principles, models, and techniques become more of the focus of the curriculum. At each successive Program level, models and applications are explored in more depth and detail. In the L3 curriculum, the focus is more on equities’ role in portfolio management.
What to Expect in CFA Level 1 Equity Investments?
This topic explores information used to make investment recommendations and decisions. The uses of fundamental analysis are discussed as the basis for investment decisions. Methods for estimating a company’s intrinsic value are discussed in detail. Equity valuation also teaches about the functions and characteristics of a wellfunctioning financial system, market efficiency, and various approaches to valuing public and private equity.
CFA Equity Investments (EI) is a heavily weighted topic on the Level 1 exam and is not only fundamental to passing Level 1 but succeeding in the CFA Program overall.
Exam Weighting
The CFA Institute’s Level I Equity Investments topic has an exam weight of 1012% of the total exam content so approximately 1822 questions of the 180 CFA Level 1 exam questions focus on this topic.
Topic Weight  No. of Learning Modules  No. of Formulas  No. of Questions 

1012%  6  Nearly 15  20 
Level 1 Equity Investments Syllabus, Readings and Changes
The 2023 CFA Level 1 Equity syllabus spans 6 learning modules and contains 63 LOS.
No. of Learning Modules: 6  No. of LOS: 63  

Summary A structural overview of financial markets and their operating characteristics is provided. Overview includes markets for equities, fixed income, derivatives, and alternative investments. Various asset types, market participants, and types of trades within these markets and ecosystems are described. The calculation, construction, and use of security market indexes are discussed together with market efficiency: how well market prices reflect available information. 
The weight of the Equity Investments topic increased from 2019 to 2023. Since 2021, it has fluctuated between 1012%. Please note that there are no changes in the CFA Level 1 Equity Investments curriculum. For a more comprehensive discussion of LOS visit the official CFAI Level 1 syllabus page.
2018  2019  2020  2021  2022  2023 

10%  11%  11%  1012%  1012%  1012% 
Market Organization and Structure
This reading provides an overview of various types of markets and the actors who participate in them. The overview includes markets for equities, fixed income, derivatives, and alternative investments.
Security Market Indexes
This reading focuses on different types of indexes, how they are constructed, and what they are used for.
Market Efficiency
This reading presents a detailed discussion on whether and/or how effectively market prices reflect the intrinsic value of securities.
Overview of Equity Securities
This reading provides a qualitative analysis of the features that distinguish equity securities from other asset classes and their roles in the capital markets.
Industry and Company Analysis
This reading looks at the comparative frameworks that are commonly used to analyze corporate equities.
Equity Valuation: Concepts and Basic Tools
This reading introduces valuation models and their appropriate applications, with details about how investors’ estimates of intrinsic value can inform trading decisions.
CFA Equity Investments Level 1 Sample Questions and Answers
The sample questions are typical of the probing multiplechoice questions on the CFA L1 exam. During the exam, you have about 90 seconds to read and answer each question, carefully designed to test knowledge from the CFA Curriculum. UWorld’s question bank is built to expose you to examlike questions and illustrate and explain the concepts tested thoroughly.
If a country’s security markets are semistrong form efficient, an investor would most likely be able to generate abnormal returns using:
 only technical analysis.
 only fundamental analysis.
 neither technical nor fundamental analysis.
The efficient market hypothesis (EMH) stipulates that markets are efficient when asset prices fully reflect all relevant information. If a market is efficient, abnormal returns cannot be consistently achieved in that market with information obtained from sources specified by the EMH.
In the semistrong form of market efficiency, asset prices are assumed to reflect all historical market data plus all publicly available information (eg, financial statements, earnings calls). Historical data and public information are both completely assimilated into prices, so an investor cannot achieve abnormal returns using those resources. An investor could achieve abnormal returns only by using insider information.
Two analytical methods are used to estimate the relative value of investments and develop investment decisions:
 Technical analysis (eg, charting techniques) uses a market’s historical trading and volume data.
 Fundamental analysis (eg, free cash flow valuation) uses publicly available data to derive an asset’s intrinsic value.
Therefore, in a semistrong form efficient market, neither technical nor fundamental analysis would be able to generate abnormal returns (Choices A and B).
Things to remember:
Under the semistrong form efficient market hypothesis, all historical market data and publicly available information are reflected in asset prices. To develop investment decisions, technical analysis uses historical market data while fundamental analysis uses publicly available data. Therefore, in a market with semistrong form efficiency, neither technical nor fundamental analysis would be able to generate abnormal returns.
Expecting a recession, a portfolio manager changes the allocation in a client’s equity portfolio by overweighting consumer staples and utilities while underweighting industrials. The portfolio manager’s action is best described as:
 risk budgeting.
 sector rotation strategy.
 tactical asset allocation.
Sector rotation is a timing strategy used to reallocate a portfolio based on an investor’s perception of the business cycle or other macro variables (eg, oil prices, yield curve shifts). Sector rotation is a common technique used by practitioners in an attempt to outperform their benchmarks and is a common application of industry analysis.
A cyclical industry is highly correlated to the strength of the overall economy, while a noncyclical industry is more insulated from economic fluctuations. By shifting away from cyclical stocks (eg, industrials) and into noncyclical stocks (eg, consumer staples, utilities), the manager is attempting to reduce the negative effects of a recession on the portfolio.
(Choice A) Risk budgeting measures and allocates risks by specific portfolio metrics (eg, beta), often limiting the total risk of the portfolio to a predetermined “budget.” Although the portfolio’s overall risk was likely reduced by the sector shifts, it was done on an ad hoc basis and nothing in the question implied that the portfolio was adhering to or constrained by a risk budget.
(Choice C) Tactical asset allocation refers to tactical shifts among various asset classes (eg, equities, fixed income), not within an asset class.
Things to remember:
Sector rotation is a timing strategy used to reallocate a portfolio based on an investor’s perception of the business cycle or other macro variables. It is a common application of industry analysis.
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What to Expect in CFA Level 2 Equity Valuation?
The CFA Level 2 Equity Valuation (EV) curriculum, formerly known as CFA Equity Investments (EI), is one of the more heavily weighted topics, with 6 of the 49 (12%) Level 2 learning modules dedicated to EV. This topic is not only fundamental to passing Level 2 but succeeding in the CFA overall. Candidates will dive deeper into the details of the concepts and principles presented in the Level 1 curriculum.
Exam Weighting
The CFA Equity Valuation weighs 1015% of the total exam content so that approximately 812 questions or 23 item sets of the CFA Level 2 exam focus on this topic.
Topic Weight  No. of Learning Modules  No. of Formulas  No. of Questions 

1015%  6  Around 100  11 
Level 2 Equity Valuation Syllabus, Readings, and Changes
The CFA Program’s Level 2 curriculum includes 49 total learning modules for 2023 out of which 6 (around 12%) of those readings focus on Equity Valuation.
No. of Learning Modules: 6  No. of LOS: 76  

Summary The initial focus is on essential equity valuation concepts, including definitions of value and the application of equity valuation models. Key return measures such as the equity risk premium and the derivation of the equity required return using various models are discussed. More models and their role in equity valuation are explained: coverage includes discounted cash flow (DCF) valuation models and an emphasis on the dividend discount model (DDM). The focus here is on additional valuation methods for estimating a company’s intrinsic value. The free cash flow model is presented as an alternative to the dividend discount model. Relative valuation, using price and enterprise value multiples, is also discussed. Residual income valuation follows. The main approaches for valuing private company equity (income, market, asset based) conclude the session. 
The data, examples, and references in all six learning modules in the Equity Valuation topic area have been refreshed, but the readings’ content remains unchanged. For a more comprehensive discussion of LOS visit the official CFAI Level 2 Curriculum Changes page.
CFA Level 2 Equity Valuation Changes  

Equity Valuation: Applications and Processes  Updated 
Return Concepts  Deleted 
Financial Statement Modeling (retitled and moved to FSA) (formerly Industry and Company Analysis)  Retitled, Revised, and Moved 
Discounted Dividend Valuation  Updated 
Free Cash Flow Valuation  Updated 
MarketBased Valuation: Price and Enterprise Value multiples  Updated 
Residual Income Valuation  Updated 
Private Company Valuation  Updated 
The weightage of the CFA Level 2 Equity Valuation has remained constant from 2019 to 2023.
2018  2019  2020  2021  2022  2023 

1525%  1015%  1015%  1015%  1015%  1015% 
Equity Valuation: Applications and Processes
This reading discusses the various definitions of value and the application of equity valuation techniques. A fivestep equity valuation process is described with the presented three main categories of equity valuation models (absolute, relative, and total entity).
Discounted Dividend Valuation
This learning module explains the calculation and interpretation of the value of a common stock using the dividend discount model (DDM) and the Gordon growth model for single and multiple holding periods. It explains the models’ underlying assumptions, interprets the implied growth rate of dividends, and compares intrinsic value and the market value based on the DDM.
Free Cash Flow Valuation
This learning module compares the free cash flow to the firm (FCFF) and free cash flow to equity (FCFE) approaches to valuation. It describes approaches for forecasting FCFF and FCFE and compares the FCFE model and dividend discount models. This reading also explains the singlestage (stablegrowth), twostage, and threestage FCFF and FCFE models and justifies the selection of the appropriate model given a company’s characteristics. It then describes how to estimate a company’s value using the appropriate free cash flow model.
MarketBased Valuation: Price and Enterprise Value Multiples
This learning module provides contrast on the valuation methods based on comparables and on forecasted fundamentals as approaches to valuation and explains economic rationales for each approach. The discussion includes rationales for and possible drawbacks to using alternative price multiples and dividend yield in estimates of intrinsic value.
Residual Income Valuation
This learning module describes, calculates, and interprets residual income and its uses in estimating the common stock’s intrinsic value, especially compared to other approaches. It explains the fundamental determinants of residual income and discusses the strengths and weaknesses of residual income models, including accounting issues in residual income model applications.
Private Company Valuation
This learning module describes issues of private business valuation. It explains the cash flow estimation issues and adjustments required to estimate normalized earnings and calculate the value of a private company using different approaches. Also included are discussions of the effects of discounts and premiums based on control and marketability on private company valuations.
CFA Equity Valuation Level 2 Sample Questions and Answers
The sample questions here are typical of the L2 exam’s complexity and depth: formatted as item sets, with a vignette to deliver a scenario that tests the CFA L2 Curriculum. (On the actual exam, each vignette applies to four questions; we’ve thrown in a couple extra to get a bit more learning in). And be sure to review the illustrated explanations we’ve provided for each question: UWorld’s question bank is designed to expose you to examlike questions and explain the concepts tested thoroughly.
Passage
Bruno Martins is a senior sellside analyst covering the technology, media, and telecom sectors. He is meeting with Mariana Dias, one of his junior analysts, to discuss valuing companies using their forecasted dividends. All dividends are assumed to be paid annually at the end of the year.
Dias is currently analyzing Terra Manufacturing and Oceano Technologies. Both companies have a stable ROE of 12%, a stable capital structure, no changes to their common stock outstanding, and a constant dividend payout ratio. However:
 Terra’s payout ratio is 60% and
 Oceano’s payout ratio is 45%
It is the beginning of 20X3, and Dias has the following forecast for Oceano’s dividends:
Exhibit 1 Dividend Forecast for Oceano (in BLR)  

Year  Dividend per share 
20X3  2.30 
20X4  2.40 
20X5  2.50 
20X6  2.60 
Martins is valuing Oceano based on a threeyear holding period and given a required rate of return of 8%. Dias uses two methods:
Method 1: Using the Gordon growth model to estimate the terminal value, Dias expects Oceano’s dividend to grow at a constant 5% rate starting in 20X6.
Method 2: Using P/E to estimate the terminal value, Dias expects Oceano’s justified forward P/E ratio at the end of 20X5 to be 11x.
Martins is analyzing three other companies and asks Dias to generate dividend expectations for each. Dias provides the following:
Exhibit 2 Dividend Expectations for Three Companies  

Ticker  Industry  Dividend Forecast 
LIFE  Technology  20X3: Dividend per share = BRL 3.80 20X4 and 20X5: Annual dividend growth rate = 3% 20X6: Make acquisition and suspend dividend 20X8: Pay specialdividend per share = BRL 8.00 20X9: Reinstate normal dividend Dividend growth thereafter = 4% 
FAIR  Telecom  20X3: Dividend per share = BRL 2.00 20X4 and 20X5: Dividend growth = 12% 20X6 and 20X7: Dividend growth = 7% Dividend growth thereafter = 4% 
VOYG  Media  20X2: Dividend per share = BRL 1.50 and dividend grew 8% 20X3: Transition to mature growth phase over 8 years Dividend will grow 3% in mature growth phase 
Martins estimates the riskfree rate at 3% and equity risk premium at 5%. He believes a stock would be over or undervalued if it’s more than 8% from its calculated intrinsic value to allow for uncertainty in the model.
All else equal, which company will have a larger sustainable dividend growth rate?
 Terra
 Oceano
 They will be equal
Companies that pay dividends are assumed to eventually mature and reach a sustainable dividend growth rate. The sustainable rate is one that a company can maintain longterm at a given ROE, assuming no changes to its capital structure and no issuances of equity. The sustainable growth rate allows analysts to calculate a:
 company’s value using the Gordon growth model and
 terminal value when using a multistage dividend discount model.
The sustainable growth rate is a function of a company’s ROE and its earnings retention rate. All else equal, a company’s sustainable growth rate will increase when its:
 ROE increases, since the company will produce more future earnings from its equity.
 earnings retention rate (ie, 1 − payout ratio) increases, since the company will have more retained equity each period to produce future earnings.
In this scenario, each company’s sustainable growth rate is calculated as:
Terra  Oceano 

g = (1 – 0.60) * 0.12 = 0.048  g = (1 – 0.45) * 0.12 = 0.066 
Oceano has a larger sustainable growth rate of 6.6% (Choices A and C). Note that this question can be completed without calculations. Since both companies have the same ROE, the one with the greater earnings retention rate will have the greater sustainable growth rate.
Things to remember:
Companies that pay dividends are assumed to eventually mature and reach a sustainable dividend growth rate. This assumption allows analysts to calculate a company’s value or terminal value using the Gordon growth model. The sustainable growth rate is a function of a company’s ROE and its earnings retention rate.
Based on Exhibit 1 and using Method 1, the value of Oceano (in BRL) is closest to:
 69.87
 72.32
 74.97
Exhibit 1 Dividend Forecast for Oceano (in BLR) 


Year  Dividend per share 
20×3  2.30 
20×4  2.40 
20×5  2.50 
20×6  2.60 
Method 1: Using the Gordon growth model to estimate the terminal value, Dias expects Oceano’s dividend to grow at a constant 5% rate starting in 20X6.
Method 2: Using P/E to estimate the terminal value, Dias expects Oceano’s justified forward P/E ratio at the end of 20X5 to be 11x.
Multistage discounted dividend model
V_{0} = ^{D1}⁄_{(1 + r)1}+^{D2}⁄_{(1 + r)2}+ … + ^{Dn}⁄_{(1 + r)n}+^{Pn}⁄_{(1 + r)n}
Discounted dividend models discount forecasted dividends to the current period, using the required return as the discount rate. The expected dividends can be forecasted in several ways (eg, growth rates, payout ratios).
Similarly, the terminal value in a discounted dividend model can be calculated in multiple ways (eg, Gordon growth model, P/E value). When an analyst or investor is using a given holding period for a stock, the expected stock price at the end of the holding period can also be used as the terminal value.
If the Gordon growth model is used to calculate the terminal value, as in Method 1 in this scenario, the next year’s dividend should be used to calculate the value in a given period. Since the holding period is three years, the dividend in Year 4, 20X6, is used to calculate the terminal value at the end of the holding period, which is the end of 20X5. Once calculated, the terminal value and the forecasted dividends are discounted back to the current period:
The value of Oceano using the Gordon growth model to estimate the terminal value (ie, Method 1) is BRL 74.97.
(Choice A) 69.87 is calculated by discounting the terminal value by 4 years (ie, 1.084) instead of 3 years.
(Choice B) 72.32 is calculated by using the dividend in 20X5 (ie, Year 3) instead of 20X6 (ie, Year 4) to calculate the terminal value.
Things to remember:
The terminal value in a discounted dividend model can be calculated in multiple ways. When using the Gordon growth model to calculate the terminal value, the next year’s dividend should be used to calculate the value in a given period.
Based on Exhibit 1 and using Method 2, the terminal value of the model at the end of 20X5 (in BRL) is closest to:
 52.00
 61.11
 63.56
Exhibit 1 Dividend Forecast for Oceano (in BLR) 


Year  Dividend per share 
20×3  2.30 
20×4  2.40 
20×5  2.50 
20×6  2.60 
Method 1: Using the Gordon growth model to estimate the terminal value, Dias expects Oceano’s dividend to grow at a constant 5% rate starting in 20X6.
Method 2: Using P/E to estimate the terminal value, Dias expects Oceano’s justified forward P/E ratio at the end of 20X5 to be 11x.
An alternative to using the Gordon growth model to calculate the terminal value is using a justified P/E ratio. The P/E ratio can be trailing (ie, backwardlooking) or leading (ie, forwardlooking). The earnings used to calculate the terminal value should be consistent with the choice of P/E ratio.
In this question, Dias expects Oceano’s forward P/E ratio at the end of 20X5 to be 11x; thus, the 20X6 dividend should be used to calculate 20X6 earnings. Since Oceano’s payout ratio is 45%, its earnings in 20X6 are forecasted to be 5.78 (≈ 2.60 / 0.45). Therefore, the price in 20X5 that is used as the terminal value is 63.56 (≈ 5.78 × 11).
(Choice A) 52.00 is calculated using the retention ratio instead of the payout ratio to calculate the earnings.
(Choice B) 61.11 is calculated using the 20X5 dividend instead of the 20X6 dividend to calculate the earnings. This value would be used if the P/E ratio were trailing.
Things to remember:
An alternative to using the Gordon growth model to calculate the terminal value is using the P/E ratio. The earnings used to calculate the terminal value should reflect the choice of P/E ratio, whether trailing or leading.
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What to Expect in CFA Level 3 Equity ‘Portfolio Management’?
CFA Level 3 Equity Portfolio Management explains the role equity investments play in portfolios, considering costs and shareholder responsibilities. It then discusses two approaches to equity portfolio management: passive (e.g., indexbased) investing and active equity strategies. There is a detailed discussion of quantitative and fundamental equity strategies, including each investment approach’s underlying rationale and portfolio design process.
A total of 4 out of the 35 (11.4%) Level 3 readings are dedicated to Equity. Candidates will dive deeper into the details of the concepts and principles presented at Level 2.
Exam Weighting
The Level 3 CFA Equity Valuation topic weighs 1015% of the total exam content, so approximately 11 of the 88 CFA Level 3 exam questions focus on this topic. Each item on the 2023 CFA Level 3 exam will have a vignette with essay or multiplechoice questions.
Topic Weight  No. of Readings  No. of Formulas  No. of Questions 

1015%  4  Around 30  11 
Level 3 Equity Investments Syllabus, Readings and Changes
The CFA Level 3 exam includes 35 total readings for 2023. The Level 3 syllabus contains 2 study sessions with 4 readings. The weightage of the Equity topic on the exam has increased after the year 2018 but remained the same from 2019 to 2023.
Study Session  No. of Readings  No. of LOS 

8  2  11 
Summary This session explains the role played by equity investments in portfolios, considering costs and shareholder responsibilities. It discusses two approaches to equity portfolio management: passive or indexbased investing and active equity strategies. The reading on passive equity investing addresses important issues such as alternative approaches to index replication and factorbased passive strategies. Tracking error, risk, and return considerations from an indexing perspective are examined.  
9  2  17 
Summary This session takes an indepth look at active equity portfolio management. A discussion of quantitative and fundamental equity strategies, including their underlying rationale and practical construction. Factorbased investing, as well as key specialized equity strategies such as activist investing and statistical arbitrage, are explored. The study session concludes with a discussion of issues important in active equity portfolio construction, including active share, active risk, risk budgeting, and constraints on portfolio construction. 
The weightage of the CFA Level 3 Equity Valuation has remained constant from 2019 to 2023.
2018  2019  2020  2021  2022  2023 

515%  1015%  1015%  1015%  1015%  1015% 
Overview of Equity Portfolio Management
This reading describes the roles of equities in the overall portfolio. It covers the types of income and costs associated with owning and managing an equity portfolio and their potential effects on portfolio performance and describes rationales for equity investment across the passiveactive spectrum.
Passive Equity Investing
This reading covers considerations in choosing a benchmark for passively managed portfolios and issues such as alternative approaches to index replication and factorbased passive strategies. Tracking error, risk, and return considerations from an indexing perspective are also discussed.
Active Equity Investing: Strategies
This reading compares fundamental and quantitative approaches to active management and analyzes bottomup and topdown active strategies, including their rationales and associated practices. It describes how fundamental active investment and quantitative active investment strategies are created.
Active Equity Investing: Portfolio Construction
This reading discusses elements of a manager’s investment philosophy that influence the portfolio construction process and approaches for constructing actively managed equity portfolios. The uses of risk budgeting and risk measures incorporated in equity portfolio construction are presented. Discuss issues important in active equity portfolio construction, including active share, active risk, risk budgeting, and constraints on portfolio construction.
CFA Equity Portfolio Management Study Tips
 Much of the Level 3 material assumes the depths and breadths of the Levels 1 and 2 curricula, so a solid review may be in order, especially if you've taken some time off between exams.
 Plan to cover this material thoroughly based on its complexity and weight on the exam. The Level 3 exam is all about portfolio management, and equity is a serious component of any portfolio–and the exam.
 When CFA candidates have work experience in finance and/or investing, most often, it's in equity. But even if you've been in the business, don't skip this topic since it has a relatively high exam weight. Although Level 3 Equity focuses more on strategic uses of its asset class, you'll still have to do the math, so be prepared.
Visit our CFA Level 1 study guide and CFA Level 2 study guide for more information.
Frequently Asked Questions
Is the CFA Level 1 Equity Investments material hard?
The Equity Investments curriculum contains nearly 15 formulas in its learning modules, but there is quite a bit of “basic” information on markets and trading as well. Equity is often considered one of the most difficult and important topics of the CFA Level 1. However, past experience with equity valuation should provide an advantage.
How do I Practice CFA L1 Equity Investments Questions?
After moving through a QBank the best method to monitor your current understanding of the content is to try mock exams. UWorld’s CFA Mock Exams closely replicate the actual CFA L1 exam experience to help you prepare and boost your confidence on test day. Like the actual CFA exam, our mock exams consist of two 2hour, 15minute sessions, each with 90 multiplechoice questions spanning multiple subjects that are not included in the standard QBank. Take a look at our CFA L1 Formula sheet page for further resources and tips.
Is the CFA Level 2 Equity Valuation material hard?
In contrast to Level 1, Equity Valuation at Level 2 focuses on a wider range of topics and goes deeper into each over its 6 readings. It is often considered one of the most difficult and important topics of the CFA Level 2. Consider this when allocating study time to the readings.
Is the CFA Level 3 Equity Portfolio Management material hard?
In contrast to Level 2, Equity Portfolio Management on Level 3 focuses on managing portfolios. It is often considered one of the most difficult and important topics of the CFA Level 3. Consider this when allocating study time to the readings.
How do I practice the CFA Level 3 Equity Portfolio Management questions?
After working through a QBank, take mock exams. UWorld is releasing its CFA Level 3 test prep in 2023, which will closely replicate the actual CFA L3 exam experience.