Equity Valuation and Analysis
From Industry to Intrinsic Value
Begin top-down: economic and industry analysis, Porter's five forces, and lifecycle stage, then company analysis of competitive strategy and moat. Valuation models divide into present value (dividend discount, free cash flow to equity, free cash flow to firm), multiplier (P/E, P/B, P/S, EV/EBITDA), and asset-based approaches. Candidates must know the Gordon growth model and its sensitivity: value rises with growth and falls with the required return, and the spread between them must be positive.
Multiples and Traps
Multiples must be applied to the right denominator: P/E to earnings attributable to common equity, EV/EBITDA to the whole firm, P/B when book value proxies assets in place. Traps include mixing trailing and forward earnings across comparables, using a levered multiple for an unlevered metric, and ignoring differences in growth, risk, and accounting policy. Preferred stock and minority interests must be treated consistently when moving between firm and equity value. Sustainable growth (retention ratio × ROE) explains why a high P/E can be justified without mispricing.
Worked Example
A stock just paid a dividend of 2.00, dividends grow 5%, and the required return is 11%. Next year's dividend is 2.10, so value = 2.10 / (0.11 − 0.05) = 35.00. If the price is 42, the implied growth is 0.11 − 2.10/42 = 6%, which you can test against fundamentals. Rule of thumb: when a model and the market disagree, reverse-engineer the market's assumption and judge whether it is defensible.