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CFA Level I · CFA Level I Exam · Introduction to Equity Valuation

An analyst estimates a stock's intrinsic value at 48 and finds the market price is 40. The analyst believes the market price is correct and the intrinsic estimate contains an error. Which interpretation is most consistent with the market being informationally efficient?

The analyst's estimate likely reflects errors in inputs or the model. Under informational efficiency, prices already incorporate available information, so a divergence is more plausibly an estimation error than a genuine mispricing, and no convergence to 48 should be expected.

  1. AThe stock is undervalued by 20% and should be bought
  2. BThe analyst's estimate likely reflects errors in inputs or modelCorrect
  3. CThe market price will converge upward to 48 soon

Explanation

If markets are efficient, prices already reflect available information, so a gap between the estimate and price more likely stems from the analyst's inputs or model than from mispricing. Treating the gap as 20% undervaluation or predicting convergence assumes the analyst's estimate is superior, which contradicts the stated belief.

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