FE-1 Equity cheat sheet

Common stock confers residual claim on earnings and assets plus voting rights; preferred stock ranks ahead of common for dividends and liquidation but typically carries no vote.

Order types: market order executes at best available price; limit order executes only at the limit or better; stop order becomes a market order once the stop price trades.

Primary market issuance channels: IPO, seasoned equity offering (follow-on), rights issue, and private placement; secondary market trading does not raise new capital for the issuer.

Market structures: quote-driven (dealer) markets versus order-driven (auction) markets; call auction sets a single clearing price, continuous trading matches orders as they arrive.

Long position profits when price rises; short position profits when price falls but has unlimited loss potential and requires margin plus borrow of shares.

Margin: initial margin sets minimum equity at purchase; maintenance margin sets minimum equity thereafter; margin call triggered when equity falls below maintenance requirement.

Depositary receipts (ADRs/GDRs) let investors hold foreign shares in local currency and jurisdiction; ETFs trade intraday like stocks; closed-end funds trade at premiums or discounts to NAV.

Total return = (ending price − beginning price + dividends) / beginning price; holding-period return spans multiple periods and is compounded, not summed.

Intrinsic value is the present value of expected future cash flows discounted at a rate reflecting risk; market price may diverge from intrinsic value.

Going-concern value assumes continued operations; liquidation value assumes asset sale; the difference is the value of the operating business as an assembled entity.

Required return (cost of equity) = risk-free rate + beta × equity risk premium under CAPM; higher beta raises the discount rate and lowers value, all else equal.

Gordon growth model: V0 = D1 / (r − g); valid only when g < r and growth is stable and perpetual; terminal value is highly sensitive to the r − g spread.

Two-stage and H-models handle high growth transitioning to stable growth; the H-model assumes growth declines linearly from gS to gL.

Value drivers: growth rate, profitability (ROE, margins), capital intensity, and risk; a valuation is only as good as its cash-flow and discount-rate assumptions.

Enterprise value = market value of equity + debt + preferred − cash; equity value = EV − net debt; use EV multiples for capital-structure-neutral comparisons.

Sensitivity analysis on discount rate and growth is mandatory reporting practice because small input changes move value materially.

Balance sheet identity: Assets = Liabilities + Equity; income statement links to retained earnings; cash flow statement reconciles net income to cash.

Revenue recognition and expense matching drive comparability; adjustments needed for one-off items, restructuring charges, and non-recurring gains.

DuPont decomposition: ROE = net margin × asset turnover × financial leverage; each factor isolates profitability, efficiency, and leverage.

Quality of earnings: compare net income to operating cash flow; persistent gap where NI exceeds CFO signals accrual risk.

Free cash flow to firm = CFO − capex + after-tax interest; FCFE = CFO − capex + net borrowing; use FCFF for EV, FCFE for equity value.

Working capital changes affect cash flow: rising receivables or inventory consume cash; rising payables release cash.

Ratio benchmarks: gross margin, operating margin, ROIC versus WACC, interest coverage, and net debt/EBITDA for leverage assessment.

Common-size statements express items as % of revenue (income) or % of total assets (balance sheet) to compare across firms and time.

DCF: forecast FCFF, discount at WACC to get EV, subtract net debt to get equity value, divide by shares for per-share value.

FCFE DCF: discount expected FCFE at cost of equity directly to equity value; appropriate when leverage is stable and known.

Dividend discount model values equity as PV of expected dividends; Gordon growth assumes constant perpetual growth g < r.

Multi-stage DDM: explicit forecast horizon plus terminal value; terminal value = D1/(r − g) at the end of the horizon.

Sustainable growth g = ROE × retention ratio (1 − payout); high payout limits internal growth.

Terminal value dominates DCF outputs when the forecast horizon is short; test sensitivity to terminal growth and WACC.

WACC = (E/V) × re + (D/V) × rd × (1 − tax); cost of equity via CAPM; use market values of debt and equity weights.

Sanity checks: implied growth must be below long-run GDP growth; implied multiples should be plausible versus peers.

P/E = price / EPS; trailing uses last 12 months, forward uses next-year estimate; compare only within similar growth and risk profiles.

PEG = P/E ÷ expected growth rate; lower PEG suggests cheaper valuation relative to growth, but ignores risk differences.

EV/EBITDA is capital-structure neutral and useful for comparing firms with different leverage; EBITDA ignores capex and working capital.

P/B = price / book value per share; most meaningful for financial institutions and asset-heavy businesses.

P/S and EV/Sales used when earnings are negative or volatile; they ignore profitability differences.

Dividend yield = DPS / price; total shareholder return includes price change plus dividends.

Peer selection must match industry, size, growth, and risk; median multiples resist outlier distortion better than mean.

Justified P/E = payout ratio / (r − g); justified P/B = (ROE − g) / (r − g); these link multiples to fundamentals.

Standard ratings: Buy/Overweight, Hold/Neutral, Sell/Underweight; each must map to expected total return versus a defined benchmark and horizon.

A research note states thesis, valuation, catalysts, risks, and a target price derived from an explicit method (DCF, multiples, or blend).

Target price = expected value per share at horizon; upside = (target − price) / price; compare to required return to justify rating.

Catalysts are identifiable events (earnings, product launch, regulatory decision) that move price toward intrinsic value.

Risk section must include downside scenario, key sensitivities, and disconfirming evidence for the thesis.

Investment thesis should be falsifiable: state what would prove it wrong and the metric that would signal it.

Compliance: disclose conflicts, distinguish fact from forecast, date all estimates, and avoid promissory language.

Earnings estimate revisions and surprise history are leading indicators of price momentum; consensus dispersion signals uncertainty.

Portfolio expected return = weighted average of asset expected returns; portfolio variance depends on covariances, not just individual variances.

Diversification benefit arises when correlations < 1; the lower the correlation, the greater the risk reduction for a given return.

Beta measures sensitivity to market: β = Cov(ri, rm) / Var(rm); portfolio beta is the weighted average of asset betas.

CAPM: E(r) = rf + β × (E(rm) − rf); alpha = actual return − CAPM-required return.

Sharpe ratio = (Rp − rf) / σp measures excess return per unit of total risk; Treynor uses beta instead of σ.

Tracking error = standard deviation of active return (portfolio − benchmark); information ratio = active return / tracking error.

Active risk budget: active weights × active returns; constraints on sector and single-name weights limit tracking error.

Rebalancing to target weights controls drift; transaction costs and taxes trade off against tracking accuracy.