CFA Level I — Equity Investments Cheatsheet
2025 Curriculum · Volume 5 · 8 Learning Modules
LM1–2 Markets & Indexes LM3 Efficiency LM4 Equity Securities LM5–7 Analysis LM8 Valuation
LM 1 — Market Organization & Structure
LM1Financial System & Asset Types
Functions of the Financial System
  • Enable borrowing/lending, risk transfer, exchange of assets, and price discovery
  • Determine rates of return that equate savings supply with borrowing demand
  • Allocate capital efficiently to highest-value uses
Asset Classifications
SecuritiesEquities, fixed income, pooled investments
ContractsForwards, futures, swaps, options
CurrenciesFiat currencies traded in FX markets
CommoditiesPhysical goods; traded via futures or spot
Real assetsReal estate, equipment, infrastructure
LM1Trading, Positions & Orders
Positions
  • Long: buy asset; profit if price rises
  • Short: borrow and sell; profit if price falls; must post margin; unlimited loss potential
  • Leveraged (margin): borrow to buy; amplifies gains and losses
Leverage ratio = Asset value / Equity value
Margin call price = P0 × (1 − initial margin) / (1 − maintenance margin)
Order Types
Market orderExecute immediately at best available price
Limit orderExecute at specified price or better
Stop-loss orderSell when price falls to stop price
Markets & Intermediaries
  • Primary: new issuance (IPOs, private placements)
  • Secondary: trading existing securities; supports primary by providing liquidity
  • Quote-driven (dealer), order-driven (exchange), brokered markets
  • Well-functioning markets: operationally efficient, informationally efficient, allocatively efficient
LM 2 — Security Market Indexes
LM2Index Construction & Weighting
Price-weightedWeight = price of stock / sum of all prices (e.g., DJIA)
Equal-weightedSame weight to each stock; requires frequent rebalancing
Market-cap weightedWeight = market cap / total market cap (e.g., S&P 500)
Float-adjusted capOnly freely tradeable shares; most common today
Fundamental-weightedRevenue, earnings, dividends, or book value
  • Price-weighted: biased toward high-priced stocks
  • Cap-weighted: biased toward large-cap; momentum tilt; no rebalancing needed
  • Equal-weighted: small-cap tilt; requires frequent rebalancing
  • Fundamental: contrarian tilt; value bias
LM2Index Returns, Uses & Types
Return Calculations
  • Price return: change in index value only (excludes income)
  • Total return: price return + reinvested income (dividends, interest)
Uses of Indexes
  • Gauge market sentiment; benchmark for active managers
  • Proxy for systematic risk and asset classes in asset allocation
  • Model portfolios for index funds and ETFs
Index Types
Broad marketWilshire 5000, Russell 3000, MSCI ACWI
Multi-marketDeveloped, emerging, frontier (MSCI, FTSE)
SectorTechnology, healthcare, financials, etc.
StyleGrowth vs. value; large/mid/small cap
Rebalancing = adjusting weights back to target. Reconstitution = changing constituent securities.
LM 3 — Market Efficiency
LM3Efficient Market Hypothesis (EMH)
Weak formPrices reflect all past market data (price, volume)
Semi-strong formPrices reflect all publicly available information
Strong formPrices reflect all info, including private/insider
Weak → technical analysis useless. Semi-strong → fundamental analysis useless. Strong → even insiders can’t earn excess returns.
  • Market value vs. intrinsic value: efficient markets → market price ≈ intrinsic value
  • Factors affecting efficiency: number of participants, information availability, trading costs, limits to arbitrage
  • Modern view: market is efficient if active investing can’t earn excess returns net of costs
LM3Anomalies & Behavioral Finance
Market Anomalies
Calendar effectsJanuary effect, day-of-week effect
MomentumPast winners continue to outperform short-term
Value effectLow P/E, low P/B stocks outperform over time
Size effectSmall-cap stocks earn higher risk-adjusted returns
Post-earnings driftPrice adjusts slowly to earnings surprises
IPO underperformanceLong-run IPO returns tend to lag market
Behavioral Biases
  • Loss aversion: pain of loss > pleasure of equal gain
  • Overconfidence: overestimate own ability; trade too much
  • Herding: follow the crowd rather than own analysis
  • Information cascades: ignore own info and follow others’ actions
  • Anomalies may reflect risk premiums, data mining, or behavioral biases
LM 4 — Overview of Equity Securities
LM4Equity Types & Features
Common sharesOwnership; voting rights; residual claim; dividends not guaranteed
Preference (preferred) sharesFixed dividend; priority over common; limited/no voting
Cumulative preferredMissed dividends accumulate; must be paid before common
Participating preferredExtra dividend if company exceeds targets
Convertible preferredCan convert to common shares at set ratio
  • Statutory voting: one vote per share per candidate
  • Cumulative voting: total votes = shares × seats; can allocate freely → favors minority
  • Dual-class shares: different voting rights (e.g., Class A voting, Class B non-voting)
LM4Public vs. Private & Cross-Border
Private vs. Public Equity
  • Private: less liquid, less regulation, potentially higher returns, higher risk
  • Public: exchange-traded, transparent pricing, regulatory disclosure
  • Going public: IPO; going private: management buyout or PE acquisition
Investing in Non-Domestic Equities
Direct investingBuy shares on foreign exchange; currency risk
Depository receipts (DRs)Trade on domestic exchange; represent foreign shares
ADR (American)US-listed; denominated in USD
GDR (Global)Listed outside issuer’s home & US; often London/Luxembourg
Equity & Company Value
  • Book value: total assets − total liabilities (accounting measure)
  • Market value: share price × shares outstanding (investor perception)
  • ROE: Net income / Average shareholders’ equity
  • Cost of equity = investor’s required return; ROE > cost of equity → value creation
LM 5–7 — Company & Industry Analysis
LM5Company Analysis: Past & Present
1Business Model
→
2Revenue Analysis
→
3Profitability
→
4Capital & Structure
  • Revenue drivers: volume, price, mix; bottom-up or top-down approach
  • Pricing power: ability to raise prices without losing volume (brand, switching costs)
  • Operating costs: fixed vs. variable; operating leverage = % of fixed costs
  • Gross margin: (Revenue − COGS) / Revenue
  • Operating margin: EBIT / Revenue
  • Working capital: current assets − current liabilities; efficiency via turnover ratios
  • Capital investments: capex, M&A; capital structure: debt/equity mix
LM6Industry & Competitive Analysis
Industry Classification
  • GICS: 4 levels — sector, industry group, industry, sub-industry (S&P/MSCI)
  • ICB: industry, supersector, sector, subsector (FTSE Russell)
  • Limitations: multi-industry companies; classification may lag reality
Porter’s Five Forces
Rivalry among competitorsHigh → lower profitability
Threat of new entrantsLow barriers → more competition
Threat of substitutesAvailable alternatives limit pricing power
Bargaining power of buyersConcentrated buyers → price pressure
Bargaining power of suppliersFew suppliers → higher input costs
PESTLE Analysis
  • Political, Economic, Social, Technological, Legal, Environmental factors
  • Competitive strategies: cost leadership vs. differentiation
LM7Forecasting
  • Forecast objects: revenue, expenses, working capital, capex, capital structure
  • Approaches: historical extrapolation, base rates, management guidance, analyst discretion
  • Top-down (macro → industry → company) vs. bottom-up (product-level)
  • Scenario analysis: base, bull, bear cases with assigned probabilities
LM 8 — Equity Valuation: Concepts & Basic Tools
LM8Present Value Models (DDM & FCFE)
Dividend Discount Model (DDM)
V0 = Σ Dt / (1 + r)t
Gordon Growth Model (constant growth)
V0 = D1 / (r − g)
  • r = required return on equity; g = constant dividend growth rate; r > g required
  • D1 = D0 × (1 + g) — use next year’s dividend, not current
  • Sustainable growth: g = ROE × retention rate (b) = ROE × (1 − payout ratio)
  • Best for: mature, stable, dividend-paying companies
Two-Stage DDM
  • Stage 1: high growth (gS) for n years; Stage 2: stable growth (gL) forever
  • Terminal value at end of Stage 1 = Dn+1 / (r − gL), discounted back to today
FCFE Model
FCFE = CFO − FCInv + Net borrowing
FCFE = cash available to equity holders after capex and debt payments. Discount at cost of equity.
LM8Multiplier & Asset-Based Models
Price Multiples
P/E (price-to-earnings)Share price / EPS; most common
P/B (price-to-book)Share price / BVPS; useful when earnings volatile
P/S (price-to-sales)Share price / Sales per share; useful for unprofitable firms
P/CF (price-to-cash flow)Share price / CFO per share
Justified P/E from Gordon Model
Justified P/E = D1/E1 ÷ (r − g) = Payout ratio / (r − g)
  • Higher payout, lower r, higher g → higher justified P/E
  • Trailing P/E (past EPS) vs. forward/leading P/E (forecast EPS)
  • Method of comparables: compare P/E to peers, sector median, or historical average
Enterprise Value (EV)
EV = Market cap + Debt + Preferred − Cash
  • EV/EBITDA: useful when capital structures differ; EBITDA usually positive
  • EV = cost of takeover; useful for cross-company comparison
Asset-Based Valuation
  • Equity value = adjusted assets − adjusted liabilities − preferred
  • Best for: holding companies, natural resource firms, liquidation scenarios
  • Least useful for: service firms, technology companies (intangible-heavy)
LM8Preferred Stock & Dividends
Preferred Stock Valuation
V0 = D / r   (perpetuity; non-callable, non-convertible)
Dividend Concepts
Regular cash dividendPeriodic payment; quarterly typical in US
Extra (special) dividendOne-time; not expected to recur
Stock dividendAdditional shares; no cash outflow; dilutes price
Stock splitIncrease shares; reduce price proportionally
Reverse splitReduce shares; increase price proportionally
Share repurchase (buyback)Company buys own shares; alternative to dividend
Dividend Chronology
1Declaration
→
2Ex-dividend
→
3Record
→
4Payment
Must buy before ex-dividend date to receive the dividend. Price typically drops by dividend amount on ex-date.
LM8Valuation Summary & Model Selection
Three Model Categories
Present value (DDM, FCFE)Intrinsic value from discounted future cash flows
Multiplier (P/E, P/B, EV/EBITDA)Relative value from comparable ratios
Asset-basedValue from adjusted net assets
  • If V0 > market price → undervalued → buy
  • If V0 < market price → overvalued → sell or avoid
  • Best practice: use multiple models and a range of inputs
Gordon model only works when g < r and g is constant. For high-growth companies, use two-stage DDM or FCFE.
High-Frequency Exam Traps & Quick Reference
Key Distinctions (frequently tested)
Weak vs. semi-strong EMHWeak = past data; semi-strong = all public info
Statutory vs. cumulative votingCumulative = total votes freely allocated → minority-friendly
Price-weighted vs. cap-weightedPrice = high-price bias; cap = large-cap bias
Trailing vs. leading P/ETrailing = last 12 months EPS; leading = forecast EPS
DDM vs. FCFEDDM = dividends; FCFE = cash available to equity
ADR vs. GDRADR = US-listed in USD; GDR = outside home + US
Book value vs. market valueBook = accounting; market = investor perception
Cost leadership vs. differentiationLow cost → volume; differentiation → pricing power
Rebalancing vs. reconstitutionRebalancing = adjust weights; reconstitution = change members
Key Formulas & Numbers
Gordon GGMV0 = D1 / (r − g)
Sustainable growthg = ROE × (1 − payout ratio)
Preferred stock valueV = D / r (perpetuity)
FCFECFO − FCInv + Net borrowing
Justified leading P/EPayout ratio / (r − g)
Enterprise valueMarket cap + Debt + Pref − Cash
ROENet income / Avg shareholders’ equity
Leverage ratioAsset value / Equity value
Total returnPrice return + income return
Equity weighting (11–14%)20–25 questions out of 180 on CFA L1
Remember: Equity valuation uses three model categories — present value (DDM/FCFE), multiplier (P/E, EV/EBITDA), and asset-based. The Gordon model requires g < r and uses D1 (not D0) in the numerator. Market efficiency determines whether active management adds value: semi-strong efficiency implies fundamental analysis cannot generate excess returns. Porter’s Five Forces and PESTLE frame industry analysis. Always use multiple valuation approaches and consider the sensitivity of your estimate to key assumptions.