Equity Valuation: Concepts and Basic Tools

Learning Objectives Coverage

LO1: Evaluate whether a security, given its current market price and a value estimate, is overvalued, fairly valued, or undervalued by the market

Core Concept

Security valuation assessment compares an analyst’s estimated intrinsic value with the current market price to determine if a security is mispriced. Identifying mispriced securities is the foundation of value investing and active portfolio management — though the viability of this approach depends on one’s assumptions about market efficiency. exam-focus valuation

Key components:

Intrinsic (fundamental) value: Based on analysis of investment fundamentals using company analysis and forecasting
Market price: Current trading price in the market
Valuation conclusion: Undervalued (buy), fairly valued (hold), or overvalued (sell)

Formulas & Calculations

Main formula:
- If V₀ > P₀ → Undervalued (Buy signal)
- If V₀ = P₀ → Fairly valued (Hold)
- If V₀ < P₀ → Overvalued (Sell signal)
Margin of safety: (V₀ - P₀) / P₀ × 100%
HP 12C steps: Not applicable for this conceptual framework

Practical Examples

Traditional Finance Example: Stock XYZ trades at $50. D CF ana l ys i sy i e l d s in t r in s i c v a l u eo f$ 65
Calculation walkthrough:
- Margin of safety = ( $65 -$ 50) / $50 = 30%
- Conclusion: Stock is undervalued by 30%
Interpretation: Strong buy signal with significant upside potential

DeFi Application defi-application

Valuing the UNI token involves estimating intrinsic value from protocol revenue and comparing it to the market price. Smart contracts can automate valuation metrics calculation from on-chain data, providing transparent, real-time inputs. The key challenge is determining appropriate discount rates for tokens, which lack the established risk models (CAPM, Fama-French) available for traditional equity securities. This is an area where DeFi valuation is still evolving.

LO2: Describe major categories of equity valuation models

Core Concept exam-focus valuation

Three main approaches to equity valuation exist: present value models, multiplier models, and asset-based models. Different models suit different companies and situations; using multiple approaches provides validation (a concept sometimes called “valuation triangulation”).

Key categories:

Present Value Models (DCF): Based on discounted future cash flows — the most theoretically sound approach, relying on forecasted cash flows
Multiplier Models: Based on market multiples of comparable companies from industry analysis
Asset-Based Models: Based on net asset values from financial statements

Formulas & Calculations

Present Value: V₀ = Σ(CFt/(1+r)^t)
Multiplier: V₀ = Multiple × Fundamental Variable
Asset-Based: V₀ = Assets - Liabilities - Preferred Stock

Practical Examples

Traditional Finance Example: Valuing Apple using DCF, P/E multiples, and book value
Calculation walkthrough:
- DCF: $150 per share
- P/E approach: 25 × $6 EPS =$ 150
- Asset-based: Not suitable for tech companies
Interpretation: Convergence of methods increases confidence

DeFi Application defi-application

Valuing MakerDAO illustrates all three approaches in a DeFi context. DCF analysis discounts the present value of stability fees. Multiplier analysis compares TVL/Market Cap ratios across lending protocols. Asset-based valuation examines DAI collateral minus liabilities. On-chain transparency enables real-time valuation updates — a significant advantage over the quarterly reporting cycle of traditional equities.

Core Concept

Corporations use various methods to distribute value to shareholders or adjust share structure. Understanding these corporate actions is essential for accurate valuation and investment analysis, particularly when comparing companies with different payout policies. Cash distributions include regular dividends and special (extra) dividends. Share adjustments encompass stock dividends, stock splits, and reverse splits. Capital returns take the form of share repurchases, which reduce shares outstanding and increase EPS. See Corporate Issuers for payout policy analysis.

Formulas & Calculations

Stock split adjustment: New shares = Old shares × Split ratio
Stock dividend: New shares = Old shares × (1 + Stock dividend %)
Post-split price: New price = Old price / Split ratio

Practical Examples

Traditional Finance Example: Company announces 2-for-1 stock split
Calculation walkthrough:
- Pre-split: 100 shares at $100 =$ 10,000 value
- Post-split: 200 shares at $50 =$ 10,000 value
Interpretation: No economic effect, just accounting change

DeFi Application defi-application

Token burns function similarly to share buybacks, reducing supply and theoretically increasing per-token value. Airdrops serve a role analogous to stock dividends, distributing additional tokens to existing holders. Smart contracts execute automatic token burns when predefined conditions are met, offering transparent and automated execution. However, tax treatment remains uncertain in many jurisdictions — a regulatory gap that makes DeFi corporate actions more complex than their traditional equivalents.

LO4: Describe dividend payment chronology

Core Concept

The dividend payment process follows a specific chronology from declaration to payment, and understanding this timing affects trading decisions and dividend capture strategies. The declaration date is when the board announces the dividend. The ex-dividend date is when the share begins trading without the dividend right — buying on or after this date means the buyer does not receive the upcoming dividend. The record date determines ownership eligibility (typically 1-2 business days after the ex-date). The payment date is when the actual distribution occurs.

Formulas & Calculations

Ex-dividend price adjustment: P(ex-div) ≈ P(cum-div) - Dividend
Days between dates: Typically 1-2 business days from ex-date to record date

Practical Examples

Traditional Finance Example: Stock trading at $50 d ec l a res$ 2 dividend
Calculation walkthrough:
- Cum-dividend price: $50
- Ex-dividend price: $48 (approximately)
Interpretation: Buy before ex-date to receive dividend

DeFi Application defi-application

In DeFi, snapshot voting and reward distribution replace the traditional dividend chronology. Block height snapshots determine eligible token holders, serving the same function as a record date but with instant, transparent record-keeping on-chain. The advantage is elimination of the settlement lag inherent in traditional equity markets. The challenge is MEV attacks around snapshot blocks, where sophisticated actors can acquire tokens just before a snapshot to capture rewards and sell immediately after.

LO5: Explain the rationale for using present value models to value equity and describe the dividend discount and free-cash-flow-to-equity models

Core Concept exam-focus formula valuation

Present value models value securities based on discounted expected future cash flows. This is the most theoretically sound approach, grounded in the time value of money concepts from Quantitative Methods. The key components are time value of money, expected future cash flows (from forecasting), and an appropriate discount rate.

Formulas & Calculations

DDM: V₀ = Σ(Dt/(1+r)^t)
FCFE Model: V₀ = Σ(FCFEt/(1+r)^t)
FCFE Calculation: FCFE = CFO - FCInv + Net borrowing

HP 12C steps:

CF₀ = 0
CF₁ = D₁ [g] [CFj]
CF₂ = D₂ [g] [CFj]
...
i = r [g] [i]
[f] [NPV]

Practical Examples

Traditional Finance Example: Value stock with $2 dividend growing at 5%, r = 10%
Calculation walkthrough:
- V₀ = D₁/(r-g) = $2 (1.05) / (0.10 - 0.05) =$ 42
Interpretation: Stock worth $42 based on dividend stream

DeFi Application defi-application

Valuing the SUSHI token based on xSUSHI staking rewards provides a direct DeFi application of the DDM. Smart contracts distribute protocol fees to stakers, creating a transparent, verifiable dividend stream. The DDM maps naturally: staking rewards serve as dividends, and the required return reflects the token’s risk premium. The main challenge is the high volatility in protocol revenues, which makes growth rate estimation far more uncertain than for traditional dividend-paying stocks.

LO6: Explain advantages and disadvantages of each category of valuation model

Core Concept

Definition: Each valuation approach has specific strengths and weaknesses affecting its applicability
Why it matters: Choosing appropriate models for specific situations improves valuation accuracy
Key components:
- Model assumptions and requirements
- Data availability and quality
- Company/asset characteristics

Formulas & Calculations

Not applicable - conceptual framework

Practical Examples

Traditional Finance Example:
- Tech startup: Multiplier models (no profits yet)
- Utility company: DDM (stable dividends)
- Real estate company: Asset-based (tangible assets)

DeFi Application

Protocol example:
- New protocols: Multiplier models (TVL ratios)
- Established protocols: DCF models (fee streams)
- Lending protocols: Asset-based (loan book value)
Implementation: Different models for different protocol types
Advantages/Challenges: Model selection crucial for accurate token valuation

LO7: Calculate the intrinsic value of a non-callable, non-convertible preferred stock

Core Concept exam-focus formula valuation

Preferred stock with fixed dividends is valued as a perpetuity — the simplest equity valuation case and a foundation for understanding more complex securities. The approach parallels fixed income valuation but without a maturity date.

Formulas & Calculations

Perpetual preferred: V₀ = D/r
With maturity: V₀ = Σ(Dt/(1+r)^t) + F/(1+r)
HP 12C steps:
```
For perpetual: D [ENTER] r [÷]
```

Practical Examples

Traditional Finance Example: $100 par preferred, 5.5% dividend, r = 6%
Calculation walkthrough:
- Annual dividend = $100 \times 0.055 =$ 5.50
- V₀ = $5.50/0.06 =$ 91.67
Interpretation: Trading below par due to required return exceeding dividend rate

DeFi Application

Protocol example: Perpetual protocol tokens with fixed reward rates
Implementation: Smart contracts ensuring fixed distribution rates
Advantages/Challenges:
- Advantage: Programmable, guaranteed payments
- Challenge: Protocol sustainability concerns

LO8: Calculate and interpret the intrinsic value of an equity security based on the Gordon (constant) growth dividend discount model or a two-stage dividend discount model, as appropriate

Core Concept exam-focus formula valuation

The Gordon model assumes constant dividend growth, while the two-stage model allows for changing growth rates. These are the most practical DDM applications for valuing dividend-paying stocks. The sustainable growth rate (g = b x ROE) connects back to company analysis and the ROE framework.

Formulas & Calculations

Gordon Model: V₀ = D₁/(r-g) = D₀(1+g)/(r-g)
Two-Stage: V₀ = Σ[D₀(1+gs)^t/(1+r)^t] + [Dn+1/(r-gL)]/(1+r)
Sustainable growth: g = b × ROE

HP 12C steps:

Gordon: D₁ [ENTER] r [ENTER] g [-] [÷]
Two-stage: Use CF register for high-growth dividends, add terminal value

Practical Examples

Traditional Finance Example: Stock pays $2 dividend, g = 5%, r = 10%
Calculation walkthrough:
- Gordon: V₀ = $2 (1.05) / (0.10 - 0.05) =$ 42
- Two-stage (5 years 10%, then 5%): Calculate each dividend, discount, sum
Interpretation: Higher near-term growth increases present value

DeFi Application defi-application

Valuing governance tokens with growing fee distributions maps directly to the Gordon and two-stage DDM frameworks. On-chain data enables real-time growth rate calculations from historical fee trends. The advantage is instant access to updated growth assumptions; the challenge is extreme volatility in growth rates, which can make the Gordon model’s constant-growth assumption unrealistic for most DeFi tokens. Two-stage models are generally more appropriate for newer protocols transitioning from high growth to maturity.

LO9: Identify characteristics of companies for which the constant growth or a multistage dividend discount model is appropriate

Core Concept

Different DDM variations suit companies at different industry lifecycle stages, and model misapplication leads to valuation errors. Company maturity and growth phase, dividend stability and predictability, and industry characteristics all determine which model is appropriate. The Gordon constant-growth model works best for mature, stable dividend payers, while multistage models are needed for companies with changing growth trajectories.

Formulas & Calculations

Not applicable - selection criteria framework

Practical Examples

Gordon Model Appropriate:
- Utilities with stable 3% dividend growth
- Consumer staples with predictable cash flows
- REITs with mandated distributions
Multistage Appropriate:
- Tech companies transitioning to maturity
- Pharmaceuticals with patent cliffs
- Cyclical companies

DeFi Application

Protocol example:
- Constant: Established DEXs with stable fee generation
- Multistage: New protocols with high initial growth
Implementation: Protocol lifecycle analysis for model selection
Advantages/Challenges: Rapid protocol evolution requires frequent reassessment

LO10: Explain the rationale for using price multiples to value equity, how the price to earnings multiple relates to fundamentals, and the use of multiples based on comparables

Core Concept exam-focus valuation

Relative valuation uses market multiples of similar companies, grounded in the law of one price. It is the quickest valuation method and is widely used by practitioners, particularly for peer comparison. Key components include comparable company selection and multiple normalization.

Formulas & Calculations

P/E from fundamentals: P₀/E₁ = (Payout ratio)/(r-g)
Justified P/E: Based on company fundamentals
Relative P/E: Company P/E / Benchmark P/E

Practical Examples

Traditional Finance Example: Tech company P/E = 30, Industry P/E = 25
Calculation walkthrough:
- Relative P/E = 30/25 = 1.20
- Premium = 20% above industry
Interpretation: Company trades at premium, investigate reasons

DeFi Application

Protocol example: P/E ratios for fee-generating protocols
Implementation: Automated multiple calculations from on-chain data
Advantages/Challenges:
- Advantage: Real-time multiple updates
- Challenge: Limited comparable protocols

LO11: Calculate and interpret the following multiples: price to earnings, price to an estimate of operating cash flow, price to sales, and price to book value

Core Concept exam-focus formula valuation

Key valuation multiples use different fundamental metrics from financial statement analysis. Different multiples suit different situations:

Earnings-based: P/E ratio (most common, requires positive earnings)
Cash flow-based: P/CF ratio (less susceptible to accounting manipulation)
Revenue-based: P/S ratio (useful when earnings are negative)
Asset-based: P/B ratio (useful for asset-heavy businesses)

Formulas & Calculations

P/E: Stock Price / EPS
P/CF: Stock Price / Cash Flow per Share
P/S: Stock Price / Sales per Share
P/B: Stock Price / Book Value per Share
HP 12C steps: Simple division calculations

Practical Examples

Traditional Finance Example: Stock at $50, EPS$ 2, Sales/share $20, B V / s ha re$ 25
Calculation walkthrough:
- P/E = $50/$ 2 = 25x
- P/S = $50/$ 20 = 2.5x
- P/B = $50/$ 25 = 2.0x
Interpretation: Compare to industry averages for relative valuation

DeFi Application defi-application

DeFi protocol valuation uses adapted multiples. P/E applies to MakerDAO’s price relative to stability fee earnings. P/S applies to Uniswap’s price relative to trading fee revenue. P/TVL (price to total value locked) is a DeFi-native metric with no traditional equivalent. Smart contract queries enable real-time metric calculation. The advantage is transparent, verifiable data; the challenge is that many protocols lack the earnings history or comparable peers needed for reliable multiple-based valuation.

LO12: Describe enterprise value multiples and their use in estimating equity value

Core Concept exam-focus formula valuation

Enterprise value multiples value the entire firm, not just equity, allowing comparison of companies with different capital structures (see Corporate Issuers). Key components include enterprise value calculation, EBITDA and other firm-level metrics, and capital structure neutrality.

Formulas & Calculations

EV: Market Cap + Debt + Preferred - Cash
EV/EBITDA: Enterprise Value / EBITDA
Equity Value: EV - Debt - Preferred + Cash

Practical Examples

Traditional Finance Example: Company with $1 B ma r k e t c a p,$ 300M debt, $100M cash
Calculation walkthrough:
- EV = $1, 000 M +$ 300M - $100 M =$ 1,200M
- If EBITDA = $200M, EV/EBITDA = 6x
Interpretation: Compare to industry EV/EBITDA for relative value

DeFi Application defi-application

Valuing DeFi protocols with treasury assets requires adapting the EV formula: EV = Token Market Cap + Protocol Debt - Treasury Holdings. This captures full protocol value and enables comparison across protocols with different treasury sizes. The main challenge is defining “debt” in a DeFi context — outstanding stablecoin liabilities (for protocols like MakerDAO) or locked incentive emissions may qualify, but no standardized accounting framework yet exists.

LO13: Describe asset-based valuation models and their use in estimating equity value

Core Concept valuation

Valuation based on net asset values rather than earnings or cash flows. This approach provides a floor value, especially useful for asset-heavy companies and alternative investments like real estate. It relies on fair value estimation from financial statement analysis.

Formulas & Calculations

Basic formula: Equity Value = Assets - Liabilities - Preferred Stock
Adjustments: Book values → Fair/market values

Practical Examples

Traditional Finance Example: Real estate company with properties
Calculation walkthrough:
- Book value of properties: $100M
- Appraised value: $120M
- Liabilities: $70M
- Equity value = $120 M -$ 70M = $50M
Interpretation: Market value exceeds book value by 20%

DeFi Application defi-application

Lending protocols with loan portfolios are the most natural candidates for asset-based valuation in DeFi. The formula is: Value = Collateral assets - Outstanding loans - Bad debt provisions. The advantage is fully transparent, on-chain asset values updated in real time. The challenge is that volatile collateral values can swing the NAV calculation significantly within hours — a pace of change that traditional asset-based models were not designed to handle.

Core Concepts Summary (80/20 Principle) exam-focus

Must-Know Concepts

Gordon Growth Model: V₀ = D₁/(r-g) - Foundation of dividend discount models formula
P/E Ratio: Price/Earnings - Most common valuation multiple
Enterprise Value: Market Cap + Debt - Cash - Firm-level valuation metric
Intrinsic vs Market Value: Determines buy/sell decisions
Present Value Principle: All valuation derives from discounted cash flows

Quick Reference Table

Concept	Formula	When to Use	DeFi Equivalent
Gordon Model	D₁/(r-g)	Stable dividend growth	Token with stable rewards
P/E Ratio	Price/EPS	Profitable companies	Protocol P/E ratios
EV/EBITDA	EV/EBITDA	Cross-capital structure	Protocol EV/Revenue
Two-Stage DDM	Complex NPV	Changing growth rates	New protocol valuation
Asset-Based	Assets - Liabilities	Tangible assets	Lending protocol NAV

Comprehensive Formula Sheet

Essential Formulas

1. Gordon Growth Model
V₀ = D₁/(r-g) = D₀(1+g)/(r-g)
Where: D₁ = next dividend, r = required return, g = growth rate
Used for: Valuing stocks with constant dividend growth

2. Two-Stage DDM
V₀ = Σ[D₀(1+gs)^t/(1+r)^t] + [Vn/(1+r)^n]
Where: gs = short-term growth, gL = long-term growth, n = high-growth periods
Used for: Companies with changing growth rates

3. FCFE Model
V₀ = Σ(FCFEt/(1+r)^t)
FCFE = CFO - FCInv + Net borrowing
Used for: Companies not paying dividends

4. Preferred Stock Valuation
V₀ = D/r (perpetual)
V₀ = Σ(D/(1+r)^t) + F/(1+r)^n (with maturity)
Used for: Fixed dividend securities

5. P/E from Fundamentals
P/E = Payout ratio/(r-g)
Used for: Justified P/E calculation

6. Enterprise Value
EV = Market Cap + Debt + Preferred - Cash
Used for: Firm-level valuation

7. Sustainable Growth
g = b × ROE
Where: b = retention rate = (1 - payout ratio)
Used for: Estimating growth rates

8. Required Return (CAPM)
r = Rf + β(Market Premium)
Used for: Calculating discount rates

HP 12C Calculator Sequences

Gordon Growth Model:
2.10 [ENTER]     (D₁)
0.10 [ENTER]     (r)
0.05 [-]         (r-g)
[÷]              Result: 42

Two-Stage DDM (Example: 3 years high growth):
[f] [FIN]        Clear financial registers
0 [g] [CF₀]      Initial investment
2.20 [g] [CFj]   Year 1 dividend
2.42 [g] [CFj]   Year 2 dividend
2.66 [g] [CFj]   Year 3 dividend
44.38 [+]        Add terminal value to Year 3
[g] [CFj]        Total Year 3 cash flow
10 [g] [i]       Discount rate
[f] [NPV]        Present value

Preferred Stock:
5.50 [ENTER]     Annual dividend
0.06 [÷]         Divide by required return
Result: 91.67

P/E Calculation:
50 [ENTER]       Stock price
2 [÷]            Divide by EPS
Result: 25

Practice Problems

Basic Level (Understanding)

Problem: A stock pays a $3 annual dividend expected to grow at 4% forever. If the required return is 9%, what is the stock’s value?
- Given: D₀ = $3, g = 4%, r = 9%
- Find: Intrinsic value V₀
- Solution:
  - D₁ = $3 \times 1.04 =$ 3.12
  - V₀ = $3.12/ (0.09 - 0.04) =$ 3.12 / 0.05 = $62.40
- Answer: The stock is worth $62.40
Problem: A company has a P/E ratio of 20 while the industry average is 15. Is it overvalued?
- Given: Company P/E = 20, Industry P/E = 15
- Find: Relative valuation
- Solution: Relative P/E = 20/15 = 1.33
- Answer: Trading at 33% premium to industry; may be overvalued unless justified by superior growth

Intermediate Level (Application)

Problem: Value a stock with high growth for 3 years then stable growth:
- Current dividend: $1
- Growth years 1-3: 15%
- Growth after year 3: 5%
- Required return: 12%
- Given: D₀ = $1, gs = 15%, gL = 5%, r = 12%, n = 3
- Find: Current value
- Solution:
  - D₁ = $1.15, D_{2} =$ 1.32, D₃ = $1.52
  - D₄ = $1.52 \times 1.05 =$ 1.60
  - V₃ = $1.60/ (0.12 - 0.05) =$ 22.86
  - V₀ = $1.15/1.12 +$ 1.32/1.12² + ( $1.52 +$ 22.86)/1.12³
  - V₀ = $1.03 +$ 1.05 + $17.35 =$ 19.43
- Answer: Stock value is $19.43
Problem: Calculate EV/EBITDA for a company:
- Market cap: $500M
- Debt: $200M
- Cash: $50M
- EBITDA: $100M
- Solution:
  - EV = $500 M +$ 200M - $50 M =$ 650M
  - EV/EBITDA = $650 M /$ 100M = 6.5x
- Answer: EV/EBITDA multiple is 6.5x

Advanced Level (Analysis)

Problem: Compare three valuation approaches for a mature utility company:
- Given:
  - Current dividend: $4
  - Dividend growth: 3%
  - Required return: 8%
  - EPS: $5
  - Industry P/E: 16
  - Book value per share: $50
  - Industry P/B: 1.5
- Find: Value using DDM, P/E, and P/B approaches
- Solution:
  - DDM: V = $4 (1.03) / (0.08 - 0.03) =$ 4.12/0.05 = $82.40
  - P/E: V = $5 \times 16 =$ 80.00
  - P/B: V = $50 \times 1.5 =$ 75.00
- Answer: DDM suggests $82.40, P / E s ugg es t s$ 80, P/B suggests $75. Va l u esco n v er g e a ro u n d$ 75-82 range, indicating fair valuation confidence.

DeFi Applications & Real-World Examples

Traditional Finance Context

Institution Example: Pension funds use DDM for dividend aristocrats portfolio selection
Market Application: Private equity firms use EV/EBITDA for leveraged buyout targets
Historical Case: Warren Buffett’s value investing using intrinsic value vs market price

DeFi Parallels

Protocol Implementation:
- Curve Finance: Vote-escrowed CRV captures protocol fees (similar to dividends)
- Compound: COMP token holders govern protocol earning interest spreads
- Uniswap: UNI governance over fee switch activation
Smart Contract Logic: Automated fee distribution based on token holdings
Advantages:
- Real-time, transparent cash flows
- Programmable dividend policies
- No intermediary custody
Limitations:
- High volatility in protocol revenues
- Regulatory uncertainty
- Smart contract risks

Case Studies

Uniswap Valuation Analysis case-study:
- Background: Leading DEX with $5B+ daily volume
- Analysis:
  - P/S ratio: Market cap / Annual volume × fee rate
  - P/E potential: If fee switch activated
  - Comparable: Traditional exchange multiples
- Outcomes: Trading at premium to TradFi exchanges
- Lessons: Growth potential justifies premium
MakerDAO Asset-Based Valuation case-study:
- Background: CDP protocol with DAI stablecoin
- Analysis:
  - Assets: Collateral in vaults
  - Liabilities: DAI outstanding
  - Surplus buffer: Protocol equity
- Outcomes: MKR value tied to surplus growth
- Lessons: Asset-based model appropriate for lending protocols

Common Pitfalls & Exam Tips

Frequent Mistakes

Mistake 1: Using g ≥ r in Gordon model (produces negative/infinite values)
- How to avoid: Ensure growth rate is less than required return
Mistake 2: Mixing trailing and forward multiples in comparisons
- How to avoid: Use consistent time periods across all companies
Mistake 3: Forgetting to add terminal value in multi-stage models
- How to avoid: Always calculate and include terminal value in final period

Exam Strategy

Time management: 90 seconds per valuation question
Question patterns:
- Gordon model calculations (30% of valuation questions)
- Multiple comparisons (25%)
- Multi-stage DDM (20%)
- EV calculations (15%)
- Conceptual (10%)
Quick checks:
- Ensure g < r for Gordon model
- Verify P/E makes economic sense (typically 10-30x)
- Check unit consistency in calculations

Key Takeaways

Essential Points

✓ Intrinsic value vs market price determines investment decisions ✓ Gordon model (V = D₁/(r-g)) is foundation for dividend valuation ✓ Multiple approaches (DCF, multiples, asset-based) provide valuation triangulation ✓ P/E relates to fundamentals through payout ratio and growth ✓ Enterprise value enables cross-capital structure comparisons

Memory Aids

Mnemonic: “GoRDon” - Growth Rate must be less than Discount rate
Visual: Valuation pyramid - DCF at base (most fundamental), multiples in middle (practical), asset-based at top (fallback)
Analogy: Valuation like home appraisal - use comparable sales (multiples), replacement cost (asset-based), and rental income (DCF)

Cross-References & Additional Resources

Prerequisite: Quantitative Methods (Time Value of Money)
Related: Financial Statement Analysis (for inputs), Portfolio Management (for required returns)
Advanced: Fixed Income Valuation (similar present value concepts)
Cross-section: Corporate Issuers (Capital Structure, payout policy)

Source Materials

Primary Reading: Volume 5, Equity Investments, Topic 8
Key Sections: Gordon Model derivation, Multiple regression analysis
Practice Questions: End-of-chapter problems focus on DDM calculations

External Resources

Videos: Aswath Damodaran valuation lectures (YouTube)
Articles: McKinsey Valuation publications
Tools:
- Financial calculators with NPV functions
- DeFi analytics platforms (DeFiLlama, Dune Analytics)
- Token Terminal for protocol P/E ratios

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Equity Valuation: Concepts and Basic Tools

Equity Valuation: Concepts and Basic Tools

Learning Objectives Coverage

LO1: Evaluate whether a security, given its current market price and a value estimate, is overvalued, fairly valued, or undervalued by the market

Core Concept

Formulas & Calculations

Practical Examples

DeFi Application defi-application

LO2: Describe major categories of equity valuation models

Core Concept exam-focus valuation

Formulas & Calculations

Practical Examples

DeFi Application defi-application

LO3: Describe regular cash dividends, extra dividends, stock dividends, stock splits, reverse stock splits, and share repurchases

Core Concept

Formulas & Calculations

Practical Examples

DeFi Application defi-application

LO4: Describe dividend payment chronology

Core Concept

Formulas & Calculations

Practical Examples

DeFi Application defi-application

LO5: Explain the rationale for using present value models to value equity and describe the dividend discount and free-cash-flow-to-equity models

Core Concept exam-focus formula valuation

Formulas & Calculations

Practical Examples

DeFi Application defi-application

LO6: Explain advantages and disadvantages of each category of valuation model

Core Concept

Formulas & Calculations

Practical Examples

DeFi Application

LO7: Calculate the intrinsic value of a non-callable, non-convertible preferred stock

Core Concept exam-focus formula valuation

Formulas & Calculations

Practical Examples

DeFi Application

LO8: Calculate and interpret the intrinsic value of an equity security based on the Gordon (constant) growth dividend discount model or a two-stage dividend discount model, as appropriate

Core Concept exam-focus formula valuation

Formulas & Calculations

Practical Examples

DeFi Application defi-application

LO9: Identify characteristics of companies for which the constant growth or a multistage dividend discount model is appropriate

Core Concept

Formulas & Calculations

Practical Examples

DeFi Application

LO10: Explain the rationale for using price multiples to value equity, how the price to earnings multiple relates to fundamentals, and the use of multiples based on comparables

Core Concept exam-focus valuation

Formulas & Calculations

Practical Examples

DeFi Application

LO11: Calculate and interpret the following multiples: price to earnings, price to an estimate of operating cash flow, price to sales, and price to book value

Core Concept exam-focus formula valuation

Formulas & Calculations

Practical Examples

DeFi Application defi-application

LO12: Describe enterprise value multiples and their use in estimating equity value

Core Concept exam-focus formula valuation

Formulas & Calculations

Practical Examples

DeFi Application defi-application

LO13: Describe asset-based valuation models and their use in estimating equity value

Core Concept valuation

Formulas & Calculations

Practical Examples

DeFi Application defi-application

Core Concepts Summary (80/20 Principle) exam-focus

Must-Know Concepts

Quick Reference Table

Comprehensive Formula Sheet

Essential Formulas

HP 12C Calculator Sequences

Practice Problems

Basic Level (Understanding)

Intermediate Level (Application)

Advanced Level (Analysis)