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

An analyst values a share at an intrinsic value of 52. The market price is 50. The analyst's estimate has a standard error that would make a difference of less than 5 within the range of estimation error. Which conclusion is most appropriate?

The 2 gap is small relative to estimation error, so the mispricing is unreliable. Intrinsic value exceeds price by only 2, less than the possible error of 5, meaning the difference could come from imprecise inputs rather than true undervaluation.

  1. AThe share is clearly undervalued and a strong buy
  2. BThe share is overvalued because estimate error is present
  3. CThe 2 gap is small relative to estimation error, so the mispricing is unreliableCorrect

Explanation

The gap between intrinsic value and price is 52 - 50 = 2, which is smaller than the plausible estimation error of 5. The apparent undervaluation could therefore arise from model or input error, so it is not a reliable signal. Option A ignores the error and B reverses the sign of the gap.

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