Note: this cheat sheet is updated for the latest 2024 and 2025’s curriculum.
If you’re following our recommended Level 1 topic study order: after going through Quant, FSA and Fixed Income, CFA Level 1 Equity Investments would be a lovely topic in comparison.
Since Equity is a relatively gentle section of the curriculum, it provides an opportunity to maximize your score without feeling like you’ve endured the academic equivalent of dental surgery. Don’t discount it! 😅
We’ve created this Level 1 Equity Cheat Sheet to help speed up your revision of this section. ☕
Our Cheat Sheet series focuses on one specific topic area for each CFA Level.
More Cheat Sheets will be published in the coming weeks, sign up to our member’s list to be notified first.
By referring to the CFA Learning Outcome Statements (LOS), we prioritize and highlight the absolute key concepts and formula you need to know for each topic. With some tips at the end too!
Let’s have a look – bookmark this and check back often to refresh your memory!
Equity Investments is an important asset class in finance, with a similar topic weight across all 3 levels of the CFA exams.
Fair warning though, as the topic weights can be somewhat deceptive. While having similar weighting to Economics, Equity Investment topics are more likely to reappear in other topics throughout the curriculum – even if indirectly.
For example, Alternative Investments are considered “alternative” because they are different than Equity (and Fixed Income) and it is difficult to understand these differences without having first acquired a strong understanding of the Equity readings.
2025’s CFA Level 1 Equity Investments’ topic weighting is 11%-14%, which means 20-25 questions of the 180 questions of CFA Level 1 exam are centered around this topic.
It is covered in Topic 6 and contains 8 Learning Modules (LMs).
Note that the CFA Level 1 Equity Investment section contains 8 Learning Modules, but only 3 of these focus exclusively on equities.
Here’s a summary of Level 1 Equity Investments chapter readings:
Learning Module # | CFA Level 1 Equity Investments Topics |
---|---|
1 | Market Organization and Structure |
2 | Security Market Indexes |
3 | Market Efficiency |
4 | Overview of Equity Securities |
5 | Company Analysis: Past & Present |
6 | Industry and Competitive Analysis |
7 | Company Analysis: Forecasting |
8 | Equity Valuation: Concepts and Basic Tools |
The Equity readings, in a nutshell, are about understanding what makes equities different as an asset class, how to value equities, and how to measure the performance of equity investments.
In short, CFA Level 1 Equity Investments teaches you:
– about the functions and characteristics of a well functioning financial system;
– about market efficiency, behavioural finance and various biases;
– how to value equity with various methods.
Leverage ratio measures the amount borrowed relative to the total value of the asset. It is also the reciprocal of the initial margin (a.k.a. trader’s equity).
Leverage \space ratio=\frac{Position \space value}{Equity \space value}
Traders receive a margin call when price of equity falls below the maintenance margin requirement.
Margin \space call \space price = P_0 \times \frac{(1-Initial \space margin)}{(1-Maintenance \space margin)}
Market orders | Order is immediately executed at best price available. |
Limit orders | Sets a minimum price for sell orders, or a maximum price for buy orders. However, order may not be executed at all if markets are fast moving or there are insufficient liquidity. |
All-or-nothing orders | Order will only be executed if the entire quantity can be traded. |
Hidden orders | Large orders that are only known to brokers/exchanges that are executing them, until the trades are executed. |
Iceberg orders | A small % of a large hidden order is executed first to gauge market liquidity, before the entire order is executed. |
Market order | Limit order | |
---|---|---|
Execution | Executed immediately at best market price | Sets a minimum sell price or a maximum purchase price on orders. Types of limit orders: a) Marketable (aggressively priced) ensures immediate execution: Limit buy order > best ask, OR Limit sell order < best bid b) Making a new market / inside the market: Best bid < Limit price < Best ask c) Behind the market: Limit buy price < Best bid Limit sell price > Best ask |
Pros | Quick execution | Ensures that price limits are never breached in transaction, more trade price certainty |
Cons | Trade price uncertainty | Order may not be partially filled, or not executed at all in a volatile market. |
Day orders | Orders that expire if unexecuted by end of day it is submitted. |
Good-till-cancelled orders | Orders that last until the buy or sell order is executed. |
Immediate or cancel orders (“fill or kill”) | As per its name, once the order is submitted it has to be immediately executed. If it is not executable immediately, the order is cancelled. |
Good-on-close (market-on-close) | Order is only executed at the close of trading. |
Stop orders (stop-loss) | Orders that come with a trigger price, designed to limit losses. E.g. stop-sell orders will execute if price is at or below stop/trigger price. Whereas, stop-buy orders will execute if price is at or above stop/trigger price. |
w_i^P=\frac{P_i}{\displaystyle \sum_{j=1}^N P_j}
w_i^E=\frac{1}{N}
w_i^M=\frac{P_iQ_i}{\displaystyle \sum_{j=1}^N P_jQ_j}
w_i^F=\frac{F_i}{\displaystyle \sum_{j=1}^N F_j}
Forms of market efficiency | Past market data | Public info | Private info | Implications |
---|---|---|---|---|
Weak-form | ✔ | ✘ | ✘ | Abnormal returns cannot be earned by trading on past price trends. Technical analysis helps maintain weak-form efficient markets. |
Semi-strong form | ✔ | ✔ | ✘ | Investors cannot achieve risk-adjusted excess returns using important public info. Fundamental analysis helps maintain semi-strong form efficient markets. |
Strong form | ✔ | ✔ | ✔ | Securities markets are not strong-form efficient as it assumes perfect markets where information is cost-free and available to everyone at the same time. Hence, abnormal profits can be made by trading on private information, which regulators try to prevent. |
Loss aversion | Individuals dislike losses more than the gains of the same amount. |
Herding | Investors follow what other investors are doing and ignores own private information. |
Overconfidence | Placing too much confidence in ability to predict. |
Information cascades | An individual copies the trades of other market participants who acted first. Related to herding. |
Representatitveness | Investors base expectations upon past experience, applying stereotypes. If-then heuristic (when investor bases expectations of future on some past/current characteristics. e.g. if A happens, then B will happen) |
Mental accounting | Keeps track of individual investment’s gains and losses separately, rather than view them as a total portfolio overall. |
Conservatism | Unwilling to radically readjust from original analysis (often heuristic & much less accurate), only adjusting directionally. Hence inability to fully incorporate impact of new information on projections and react slowly. |
Narrow framing | Investors focus on issues in isolation. |
2. Putable shares have a lower risk than callable or non-callable shares because they can be sold back to the issuer if the stock price falls below a threshold. Hence putable shares have lower dividends.
3. Callable common and preference shares are more risky than their non-callable equivalents because the issuer can buy back the shares at a pre-determined price.
4. Similarly, cumulative shares have a lower risk (and hence lower dividends) than non-cumulative shares as they accrue unpaid dividends.
Operating \space income=[Q \times (P-VC)] - FC
Whereby Q = Units sold in a period,P = Price per unit, VC = Variable operating cost per unit, FC = Fixed operating costs, (P-VC) = Contribution margin per unit
Degree \space of \space operating \space leverage \space (DOL)= \frac{\% \vartriangle \space Operating \space Income}{\%\vartriangle \space Sales}
Degree \space of \space financial \space leverage \space (DFL)= \frac{\% \vartriangle \space Net \space Income}{\%\vartriangle \space Operating \space Income}
Degree \space of \space total \space leverage \space (DTL)= DOL \times DFL
WACC = Weight of debt x Gross cost of debt x (1 – t) + Weight of equity x Cost of equity
Embryonic | Slow growth, high prices, high failure risk, significant investment required. |
Growth | Rapidly increasing demand, improved profitability, lower prices, relatively low competition. |
Shakeout | Slowing growth, intense competition, focus on cost reduction, declining profitability, some failures/mergers. |
Mature | Little or no growth, industry consolidation, high barriers to entry, strong cashflows. |
Decline | Negative growth, excess capacity, high competition, weaker firms exit. |
A relatively straightforward Learning Module once you read it. Make sure you know – in particular – the various top down and bottom up approaches to forecasting revenues.
Intrinsic value = PV of future dividends + PV of terminal value
V_0=\displaystyle \sum_{t=1}^n \frac{D^t}{(1+r)^t} + \frac{P^n}{(1+r)^n}
Gordon growth model assumes dividends grows forever at a constant rate.
V_0= \frac{D_0(1+g)}{r-g} = \frac{D_1}{r-g}
where g = dividend growth rate
= earnings retention ratio x ROE
= (1- dividend payout ratio) x ROE
\begin{align*} V_0&=\displaystyle \sum_{t=1}^n \frac{D_t}{(1+r)^t}+ \frac{P_n}{(1+r)^n} \\ where \space P_n&=\frac{D_{n+1}}{r-g_L}, \\D_{n+1}&=D_0(1+g_S)^n(1+g_L) \end{align*}
For valuation of perpetual, non-callable, non-convertible preferred share with constant dividend:
V_0=\frac{D_0}{r}
\begin{align*} Forward, \space Leading, \space or \space Justified \space P/E&=\frac{P_0}{E_1} \\&=\frac {D_1/E_1}{r-g} \\&=\frac{Dividend \space payout \space ratio}{r-g} \end{align*}
P/B=\frac{Price \space per \space share}{Book \space value \space per \space share}
P/S=\frac{Price \space per \space share}{Sales \space per \space share}
P/CF=\frac{Price \space per \space share}{Cashflow \space per \space share}
Enterprise value is an alternate measure for equity which measures the market value of a firm’s debt and equity. It can be viewed as the cost of taking over a company.
EV = Market value of debt + Market value of equity + Market value of preferred stock – cash and short term investments
EV/EBITDA multiple is useful for comparing companies with different capital structures, to evaluate the cost of a takeover and for analyzing loss making companies.
That said, a limitation of EV method is that market value of debt can be hard to estimate.
As noted above, the Equity topic is among the more “pleasant” parts of the Level 1. This is not to say that the Equity Investments material is easy and can be taken for granted – just that it contains few(er) nasty surprises.
Given it’s relative ease compared to its topic weight for CFA Level 1, mastering this topic is a good return on investment, don’t skip it!
Our recommended CFA Level 1 topic study order suggests covering Equity right after the big, more demanding topics such as Quant, FRA and Fixed Income.
While it is reasonable to expect that the majority of Equity questions will be qualitative, don’t assume that the questions that do require calculations will be simple.
It is therefore important to become familiar with your calculator – specifically, the features that allow you to determine the present value of a series of cash flows.
It is also important to develop a fluency with the formulae associated with these readings. By “fluency,” I mean knowledge of a formula beyond being able to recite it from memory, such as the ability to rearrange or restate it in order to solve for a given variable.
For example, know how to use the Gordon growth model to solve for the long-term growth rate or required return, not just the present value. Such fluency is also required in order to answer the following example question:
A company has recently paid a dividend of $1.20 per share. Analysts expect the company to maintain its 40% retention rate and increase its dividend per share dividend at an annual rate of 3.0% indefinitely. If the market requires a 9.0% return on equity, the forward price-to-earnings (P/E) ratio for the company’s stock is closest to:
A. 6.7
B. 10.0
C. 10.6
The correct answer is B.
The forward P/E for a stock is calculated as followsP0/E1 = (D1/E1)/(r – g) where P0 = current stock price
E1 = next period’s earnings per share
D1 = next period’s dividends per share
r = required rate of return
g = dividend growth rate
Note that D1/E1 is the dividend payout ratio, which is calculated as one minus the retention ratio (or 1 – b).We can restate the above formula as follows
P0/E1 = (1 – b)/(r – g) = (1 – 40%)/(9% – 3%)
= 10.0
It is possible to disregard the value of next period’s dividend and earnings per share because, having restated the formula, all that matters is their ratio relative to each other and we know that this will not change because we are told that the company is expected to maintain its retention rate (and therefore maintain its payout ratio).
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Will there be any cheat sheets for CFA L2?
Are there any cheat sheets for CFA L2?
Not yet - we're working on it!