CFA Level II

Equity Valuation:
Applications and Processes
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Level II topics
1. Equity Valuation: Applications and Processes
2. Return Concepts
3. Industry and Company Analysis
4. Discounted Dividend Valuation
5. Free Cash Flow Valuation
6. Market-Based Valuation: Price and Enterprise Value Multiples
7. Residual Income Valuation
8. Private Company Valuation

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 Learning outcomes
https://www.facebook.com/hedgeacademyvn/ ● Define valuation and intrinsic value and explain sources of perceived mispricing
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● Explain the going concern assumption and contrast a going concern value to a
liquidation value
● Describe definitions of value and justify which definition of value is most relevant to
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public company valuation

● Describe applications of equity valuation
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● Understanding the Business

● Contrast absolute and relative valuation models and describe examples of each type
of model
● Describe sum-of-the-parts valuation and conglomerate discounts
● Explain broad criteria for choosing an appropriate approach for valuing a given
company

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 Intrinsic value and sources of perceived mispricing
https://www.facebook.com/hedgeacademyvn/ ● Intrinsic value (IV): value of the asset given a hypothetically complete
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understanding of the asset’s investment characteristics.

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● Sources of mispricing:
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● IVanalyst − price = (IVactual − price) + (IVanalyst − IVactual)

● actual mispricing: IVactual − price
● valuation error: IVanalyst − Ivactual

● Going-concern assumption:
● the assumption that a company will continue to operate as a business
● If the company will not continue, consider liquidation value: net asset value
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 Definitions of value
https://www.facebook.com/hedgeacademyvn/ ● Fair value: the price at which an asset (or liability) would change hands between
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willing, informed buyer and seller, under no compulsion

● Investment value: the value of a stock to a particular buyer
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● When to use:
● Intrinsic value: For most investment decisions
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● Investment value: For acquisitions

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 Applications of equity valuation
https://www.facebook.com/hedgeacademyvn/ ● Applications:
Planning and consulting
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● Stock selection ●
● Reading the market ● Communication with analysts and
● Projecting the value of corporate actions investors
● Fairness opinions ● Valuation of private business
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● Portfolio management

Process:
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●
1. Understand the business.
2. Forecast company performance.
3. Select the appropriate valuation model.
4. Convert the forecasts into a valuation.
5. Apply the valuation conclusions.

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 Understanding the Business
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● Porter's 5 forces
● 3 Strategies: Cost leadership, product differentiation, focus
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● Considerations in Using Accounting Information

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● Accelerating or premature recognition of income

● Reclassifying gains and nonoperating income
● Amortization, depreciation, and discount rates
● Off-balance-sheet issues

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 Valuation models - General topics
https://www.facebook.com/hedgeacademyvn/ ● Absolute vs relative valuation models
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● Absolute: value arising from its investment characteristics without regard to the
value of other firms
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● Relative: value of an asset in relation to the values of other assets

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● Criteria for selecting appropriate model:

● Fits the characteristics of the company (e.g., Does it pay dividends? Is earnings
growth estimable? Does it have significant intangible assets?)
● Is appropriate based on the quality and availability of input data
● Is suitable given the purpose of the analysis

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 Valuation models - General topics
https://www.facebook.com/hedgeacademyvn/ ● Sum-of-the-parts valuation (SOTP)
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● Definition: Sum of the estimated values of each of the company’s businesses

● Conglomerate discount: market applies a discount to the stock of a company
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operating in multiple, unrelated. Reasons:

● 1. Internal capital inefficiency: The company’s allocation of capital to different
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divisions may not have been based on sound decisions.

● 2. Endogenous (internal) factors: company buys unrelated business to hide poor
operating performance.
● 3. Research measurement errors: Some hypothesize that conglomerate
discounts are a result of incorrect measurement.

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 Compiled by Hedge Academy (+84) 0869231510
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question?
Hope you pass all levels!
Do you have any
Thank you

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