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

An analyst estimates a stock's intrinsic value at 60. The analyst's estimate has an expected error, and the market price is 50. The analyst reasons that the true intrinsic value is 55, and that the analyst's estimate of 60 contains an estimation error of 5. The perceived (analyst-estimated) mispricing of 10 is made up of true mispricing of 5 and estimation error of 5. This decomposition is most consistent with which statement?

The analyst's estimated value minus market price equals true mispricing plus estimation error. Here 60 minus 50 is 10, which splits into true mispricing of 5 (55 minus 50) and estimation error of 5 (60 minus 55), so the perceived gap overstates the real opportunity.

  1. AThe stock's market price must equal its intrinsic value of 55.
  2. BThe analyst's estimated value minus market price equals true mispricing plus estimation error.Correct
  3. CTrue mispricing is defined as the analyst's estimate minus true intrinsic value.

Explanation

Estimated value minus price = (true value minus price) + (estimate minus true value) = 5 + 5 = 10. The price of 50 differs from 55, so A is wrong. True mispricing is true value minus price, not estimate minus true value, so C is wrong.

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