5.4 Equity Valuation Methods

Series 65 Uniform Investment Adviser Law

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1 Introduction

About the Series 65 How to Use This Guide

2 Chapter 1: Economic Factors & Business Cycles

1.1 Business Cycles 1.2 Monetary Policy 1.3 Fiscal Policy 1.4 Inflation & Deflation 1.5 Interest Rates & Yield Curves 1.6 Global Economic Factors

3 Chapter 2: Financial Reporting & Analytical Methods

2.1 Financial Statements Overview 2.2 Accounting Fundamentals 2.3 SEC Filings & Annual Reports 2.4 Financial Ratios 2.5 Time Value of Money 2.6 IRR and NPV 2.7 Descriptive Statistics

4 Chapter 3: Types of Risk

3.1 Systematic (Market) Risk 3.2 Unsystematic (Company-Specific) Risk 3.3 Interest Rate & Reinvestment Risk 3.4 Inflation & Currency Risk 3.5 Liquidity Risk & Opportunity Cost 3.6 Risk Measurement & Portfolio Theory

5 Chapter 4: Cash Equivalents & Fixed Income Securities

4.1 Cash & Cash Equivalents 4.2 Treasury Securities 4.3 Agency Securities 4.4 Corporate Bonds 4.5 Municipal Bonds 4.6 Bond Pricing & Yields

6 Chapter 5: Equity Securities

5.1 Common Stock 5.2 Preferred Stock 5.3 Shareholder Rights & Corporate Actions 5.4 Equity Valuation Methods 5.5 ADRs, REITs & Other Equity Securities

7 Chapter 6: Pooled Investments

6.1 Mutual Funds 6.2 Mutual Fund Costs & Fees 6.3 Exchange-Traded Funds (ETFs) 6.4 Closed-End Funds & UITs 6.5 Hedge Funds & Private Equity

8 Chapter 7: Derivatives, Alternative Investments & Insurance Products

7.1 Options Basics 7.2 Options Strategies 7.3 Alternative Investments 7.4 Annuities 7.5 Life Insurance Products

9 Chapter 8: Client Types & Profiles

8.1 Individual Clients 8.2 Business Entity Clients 8.3 Trusts & Estates 8.4 Accredited & Qualified Investors 8.5 Suitability & Know Your Customer

10 Chapter 9: Portfolio Theory & Capital Markets

9.1 Modern Portfolio Theory 9.2 Capital Asset Pricing Model (CAPM) 9.3 Efficient Market Hypothesis 9.4 Risk & Performance Measures 9.5 Asset Allocation

11 Chapter 10: Portfolio Management Strategies

10.1 Investment Styles 10.2 Portfolio Management Techniques 10.3 Fixed Income Strategies 10.4 Return Calculations

12 Chapter 11: Tax Considerations & Retirement Planning

11.1 Capital Gains & Investment Taxes 11.2 Retirement Plans Overview 11.3 Individual Retirement Accounts (IRAs) 11.4 Education Savings Plans 11.5 Distributions & RMDs

13 Chapter 12: ERISA, Special Accounts & Performance Measures

12.1 ERISA Requirements 12.2 Special Account Types 12.3 Performance Measures & Reporting 12.4 QDROs & Special Situations

14 Chapter 13: Regulation of Investment Advisers

13.1 Investment Advisers Act of 1940 13.2 Registration Requirements 13.3 Recordkeeping Requirements 13.4 Custody Requirements 13.5 Exempt Reporting Advisers

15 Chapter 14: Regulation of Investment Adviser Representatives

14.1 IAR Definition & Requirements 14.2 Registration & Post-Registration 14.3 IARs of Federal Covered Advisers

16 Chapter 15: Regulation of Broker-Dealers & Agents

15.1 Broker-Dealer Definition 15.2 Agent Registration 15.3 Regulation Best Interest

17 Chapter 16: Securities Registration & Exemptions

16.1 Uniform Securities Act 16.2 Securities Registration Methods 16.3 Exempt Securities 16.4 Exempt Transactions

18 Chapter 17: Communications & Client Relationships

17.1 Advertising Rules 17.2 Social Media & Electronic Communications 17.3 Client Agreements & Disclosure 17.4 Proxy Voting & Other Obligations

19 Chapter 18: Ethics & Fiduciary Obligations

18.1 Fiduciary Duties 18.2 Prohibited Practices 18.3 Senior & Vulnerable Adult Protection 18.4 AML & Compliance Programs

5.4 Equity Valuation Methods

Key Takeaways Explain This Topic AI

P/E is the most common multiple and reflects growth expectations.

P/B is useful for asset-heavy firms and financial companies.

P/S helps value firms with low or negative earnings.

PEG adjusts P/E for growth; PEG below 1 may signal undervaluation.

DDM values stocks as the present value of dividends.

DCF works for any company with projectable cash flows.

Compare valuation metrics to peers and historical ranges.

Last updated: December 2025

Investment advisers use various methods to determine whether stocks are fairly valued. Understanding these valuation techniques is essential for making investment recommendations and is heavily tested on the Series 65 exam.

• Two Approaches to Valuation
• Fundamental Analysis

Fundamental analysis examines a company's financial statements, economic conditions, and business prospects to determine its intrinsic value.

• Analyzes earnings, revenue, assets, and liabilities
• Considers industry conditions and competitive position
• Projects future cash flows and earnings
• Compares intrinsic value to market price
• Technical Analysis

Technical analysis studies price patterns, trading volume, and market trends to predict future price movements.

• Charts and trend analysis
• Support and resistance levels
• Moving averages and momentum indicators
• Ignores fundamentals—focuses only on price and volume

Most questions on the Series 65 focus on fundamental analysis and specific valuation ratios.

Price-to-Earnings Ratio (P/E)

The P/E ratio is the most widely used valuation metric. It shows how much investors are willing to pay for each dollar of earnings.

Formula P/E Ratio = Market Price per Share Earnings per Share (EPS) \text{P/E Ratio} = \frac{\text{Market Price per Share}}{\text{Earnings per Share (EPS)}} P/E Ratio = Earnings per Share (EPS) Market Price per Share ​

Types of P/E

• Type Uses Advantage
• Trailing P/E Past 12 months actual earnings Based on real numbers
• Forward P/E Estimated future earnings More forward-looking
• Interpreting P/E

• P/E Level Typical Interpretation
• High P/E (20+) Growth expected; investors pay premium
• Low P/E (<15) Value stock; slow growth or problems
• Negative P/E Company has losses; P/E not meaningful
• In Practice

A company with a P/E of 25 means investors pay $25 for every $1 of current earnings. If the industry average is 18, the stock is trading at a premium—either the market expects higher growth, or the stock may be overvalued.

• Limitations
• Cannot use when earnings are negative
• Earnings can be manipulated through accounting choices
• Doesn't account for differences in growth rates
• Price-to-Book Ratio (P/B)

The P/B ratio compares market value to accounting (book) value.

• Formula P/B Ratio = Market Price per Share ÷ Book Value per Share
• Where: Book Value = (Total Assets - Total Liabilities) ÷ Shares Outstanding
• Interpreting P/B

• P/B Level Interpretation
• P/B < 1 Stock trades below book value; may be undervalued
• P/B = 1 Stock trades at book value
• P/B > 1 Market values company above accounting value
• Best Use Cases
• Financial institutions (banks, insurance companies)
• Asset-heavy companies (real estate, utilities)
• Distressed or cyclical companies
• On the Exam

A P/B ratio below 1.0 doesn't automatically mean "buy"—it may indicate the market expects write-downs of assets or future losses. Always consider why a stock trades below book value.

Price-to-Sales Ratio (P/S)

The P/S ratio compares stock price to revenue rather than earnings.

• Formula P/S Ratio = Market Price per Share ÷ Revenue per Share
• Or: Market Capitalization ÷ Total Revenue
• Advantages
• Can use when earnings are negative
• Revenue is harder to manipulate than earnings
• Useful for young or high-growth companies
• Limitations
• Ignores profitability completely
• Industry-specific (compare within same industry)
• Low-margin businesses have low P/S by nature
• PEG Ratio

The PEG ratio adjusts P/E for expected growth, making it useful for comparing companies with different growth rates.

• Formula PEG Ratio = P/E Ratio ÷ Expected Earnings Growth Rate (%)
• Interpreting PEG

• PEG Interpretation
• PEG < 1 Stock may be undervalued relative to growth
• PEG = 1 Stock fairly valued relative to growth
• PEG > 1 Stock may be overvalued relative to growth
• Example

• Company P/E Growth Rate PEG
• Company A 30 30% 1.0
• Company B 15 10% 1.5

Despite a higher P/E, Company A has a lower PEG and may be the better value when considering growth.

Dividend Discount Model (DDM)

The Dividend Discount Model values a stock as the present value of all expected future dividends.

Basic DDM Formula Stock Value = D₁ / (r - g)

Where:

• D₁ = Expected dividend next year
• r = Required rate of return (discount rate)
• g = Expected dividend growth rate (must be < r)

This is also called the Gordon Growth Model or Constant Growth Model .

Example

A stock pays a $2 dividend expected to grow at 5% annually. The required return is 12%. D₁ = $2.00 × 1.05 = $2.10

Value = $2.10 / (0.12 - 0.05) = $2.10 / 0.07 = $30.00

If the stock trades at $25, it may be undervalued. If it trades at $40, it may be overvalued.

Assumptions and Limitations

• Assumption Limitation
• Dividends grow at constant rate forever Few companies maintain constant growth
• Growth rate is less than required return Model breaks if g ≥ r
• Company pays dividends Cannot use for non-dividend stocks
• Dividends reflect value accurately May not apply to growth companies
• On the Exam

The DDM is most appropriate for:

• Mature, stable companies
• Companies with consistent dividend history
• Utility stocks, blue-chip stocks
• Companies with predictable earnings

The DDM is NOT appropriate for:

• High-growth companies reinvesting earnings
• Companies that don't pay dividends
• Cyclical companies with volatile earnings
• Discounted Cash Flow (DCF) Analysis

DCF analysis values a company based on the present value of projected free cash flows.

• Basic Approach
• Project free cash flows for a forecast period (5-10 years)
• Calculate terminal value at end of forecast period
• Discount all cash flows to present value at required return
• Sum = Intrinsic value of the company
• Free Cash Flow vs. Dividends

• Model Uses Best For
• DDM Dividends only Dividend-paying stocks
• FCF Model Operating cash flows All companies, control perspective

DCF is more flexible than DDM because it can value any company regardless of dividend policy.

Relative Valuation

Relative valuation compares a company to peers using multiples.

Common Comparable Multiples

• Multiple Calculation When to Use
• P/E Price / EPS Profitable companies
• EV/EBITDA Enterprise Value / EBITDA Capital-intensive businesses
• P/B Price / Book Value Financial firms, asset-heavy
• P/S Price / Sales High-growth, unprofitable
• Process
• Identify comparable companies (same industry, size, growth)
• Calculate multiples for all comparables
• Apply average or median multiple to target company
• Estimate target's intrinsic value
• Key Takeaways
• P/E ratio is most common; higher P/E suggests higher growth expectations
• P/B ratio compares to accounting value; useful for asset-heavy companies
• P/S ratio works when earnings are negative; compare within industry
• PEG ratio adjusts P/E for growth; PEG < 1 may indicate undervaluation
• Dividend Discount Model values stock as PV of future dividends; requires stable, dividend-paying company
• DCF analysis is more flexible; works for any company with projectable cash flows
• Always compare valuations to industry peers and historical averages

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