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Equity InvestmentsModule 6 of 6

Equity Valuation: Concepts and Basic Tools

6

Concepts

6

Formulas

1

Decisions

4

Quiz Questions

Key Concepts

6 concepts covered in this module.

Intrinsic Value

True worth based on fundamentals. Compare to market price: undervalued if V > P.

Dividend Discount Model (DDM)

V = Σ Dt/(1+r)t. Value of stock = PV of all expected future dividends.

Gordon Growth Model

V = D1/(r - g). Assumes constant growth forever. Only works if r > g.

Price Multiples

P/E, P/B, P/S, P/CF. Quick relative valuation. Compare to peers and history.

Justified P/E

From Gordon model: Justified P/E = (1-b)/(r-g) where b = retention ratio, g = b × ROE.

Enterprise Value Multiples

EV/EBITDA: useful for comparing firms with different capital structures. EV = Market Cap + Debt - Cash.

Formulas

6 essential formulas for this module.

Gordon Growth Model

V0 = D1 / (r - g)

Where: D1 = next year dividend, r = required return, g = constant growth

Multi-Stage DDM

V = Σ Dt/(1+r)t + Vn/(1+r)n

Where: Vn = terminal value using Gordon model

Sustainable Growth Rate

g = b × ROE

Where: b = retention ratio = 1 - payout ratio

Trailing P/E

P/E = Market Price / EPS (last 12 months)

Where: Based on past earnings

Forward P/E

P/E = Market Price / Expected EPS

Where: Based on forecasted earnings

Enterprise Value

EV = Market Cap + Total Debt - Cash

Where: Value of entire firm (equity + debt)

Decision Frameworks

1 decision frameworks to guide your analysis.

When to use DDM vs Multiples?

  • DDM: mature dividend-paying companies, when dividends are predictable
  • Multiples: quick comparison, when detailed forecasting is impractical
  • EV/EBITDA: comparing firms with different leverage

Mind Map

Visual overview of how concepts connect in this module.

Equity Valuation
Discounted CF
DDM: PV of dividends
Gordon: D1/(r-g)
Multi-stage DDM
FCFE/FCFF models
Price Multiples
P/E (trailing/forward)
P/B
P/S
P/CF
EV Multiples
EV/EBITDA
EV/Sales
EV = MCap + Debt - Cash
Key Inputs
Required return (CAPM)
Growth rate (b×ROE)
Dividend payout
Comparable firms
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Intrinsic Value

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Answer
True worth based on fundamentals. Compare to market price: undervalued if V > P.
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