Investment Analysis and Valuation
Investment Analysis and Valuation tests intrinsic value, discounted cash flow, dividend discount models, relative valuation, and the quality of assumptions. The exam rewards consistent cash flows and discount rates more than precise decimals.
Core rules
- Intrinsic value is the present value of expected future cash flows at a required return.
- Match cash flow to discount rate: equity cash flows to cost of equity; firm cash flows to WACC.
- Gordon growth model: P = D1 ÷ (r − g), where D1 is next year's dividend; g must be below r for stability.
- Multiples such as P/E, P/B, and EV/EBITDA are shortcuts; compare similar firms and adjust for growth, risk, and leverage.
- Terminal value can dominate DCF value; test growth and discount-rate sensitivity.
- Accounting earnings are not cash flow; check working capital, capex, and one-offs.
Worked example
A stock just paid D0 = PHP 5. Dividends are expected to grow 3% forever; required return is 10%. D1 = 5 × 1.03 = PHP 5.15. P = 5.15 ÷ (0.10 − 0.03) = 5.15 ÷ 0.07 = PHP 73.57. If an analyst uses D0 by mistake, the value is 5 ÷ 0.07 = PHP 71.43, understating value. If g rises to 10%, the model breaks down because the denominator is zero.
Traps
Do not use trailing dividend when the model requires next year's. Do not use g ≥ r. Do not mix nominal cash flows with real discount rates. Do not treat a low P/E as automatically cheap. Do not ignore dilution or cyclical earnings.