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

An analyst values a firm using a model, then finds that the stock's market price is 25% below her estimate of intrinsic value. She is confident in her inputs. Her conclusion is most likely that the stock is:

The stock appears undervalued, provided her inputs are reasonable and the market eventually recognizes the value. A price below estimated intrinsic value signals undervaluation, but the conclusion depends on the inputs. Market price does not always equal intrinsic value, so assuming fair value or overvaluation is incorrect.

  1. Aovervalued, and the market has priced in additional risk she should ignore
  2. Bfairly valued, because market price always equals intrinsic value
  3. Cundervalued, provided her inputs are reasonable and the market will eventually recognize the valueCorrect

Explanation

If market price is below the analyst's estimate of intrinsic value, the stock appears undervalued, conditional on the analyst's inputs being sound and the mispricing being correctable. Market price does not always equal intrinsic value, so fair value is not implied, and the stock is not overvalued.

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