Equity Investments is where the CFA curriculum starts to feel like what most candidates signed up for — analyzing stocks, valuing companies, and understanding how markets work. It carries an 11-14% weight at Level 1, making it one of the three heaviest subjects alongside FRA and Fixed Income.
The good news: if you find investing genuinely interesting, this section will feel less like studying and more like building real analytical skills. The challenge: the exam tests conceptual understanding, not just formula application. You need to know when and why to use each valuation approach, not just how.
What Equity Investments Covers
Market Organization and Structure
Before you can analyze stocks, you need to understand the infrastructure they trade on. This section covers:
- Types of financial intermediaries (brokers, dealers, exchanges)
- Order types (market orders, limit orders, stop orders)
- Market structures (quote-driven vs. order-driven markets)
- Margin trading and short selling mechanics
- Market efficiency concepts
Why it matters for the exam: Market structure questions are often straightforward and fact-based. They’re quick points if you’ve done the reading. Don’t skip this section thinking it’s boring — it’s among the easiest marks in the entire Equity topic.
Security Market Indices
You’ll learn how indices like the S&P 500, FTSE 100, and Nifty 50 are constructed and what that construction means for their behavior.
Key concepts:
- Price-weighted vs. value-weighted vs. equal-weighted indices
- Rebalancing and reconstitution
- Uses and limitations of indices as benchmarks
Common exam question: “If the highest-priced stock in a price-weighted index does a 2-for-1 stock split, what happens to the index?” Understanding index construction mechanics is essential.
Industry and Company Analysis
This is where you learn to think like an equity analyst. You’ll cover:
- Industry classification systems
- Industry life cycle analysis (embryonic, growth, shakeout, mature, decline)
- Porter’s Five Forces framework
- Company analysis within an industry context
Practical insight: When I was working in equity research, industry analysis was always the starting point. You don’t analyze a company in isolation — you analyze it within its competitive landscape. The CFA curriculum gets this exactly right.
Equity Valuation Models
This is the heart of the Equity section. You’ll learn several approaches to valuing stocks:
Dividend Discount Model (DDM):
- Gordon Growth Model (constant growth)
- Multi-stage DDM
- Assumptions and limitations
Price Multiples:
- Price-to-Earnings (P/E) — trailing and forward
- Price-to-Book (P/B)
- Price-to-Sales (P/S)
- EV/EBITDA
Asset-based valuation:
- When it’s appropriate (holding companies, distressed situations)
- Limitations in practice
Free Cash Flow Models:
- FCFF (Free Cash Flow to the Firm)
- FCFE (Free Cash Flow to Equity)
- When to use each
Market Efficiency
The Efficient Market Hypothesis and its three forms — weak, semi-strong, and strong — are testable and important. You also need to understand market anomalies and behavioral finance concepts that challenge the EMH.
Why Equity Investments Matters
High exam weight: At 11-14%, you can expect roughly 20-25 questions. Strong performance here significantly boosts your overall score.
Real-world applicability: Unlike some CFA topics that feel abstract, Equity skills translate directly to investment analysis careers. The valuation models you learn here are the same ones used by analysts at Goldman Sachs, Morgan Stanley, and every major investment firm. If you’re curious about how the CFA charter supports a career in the markets, read our article on stock market success with the CFA.
Foundation for Level 2: Equity at Level 2 becomes significantly more complex, with residual income models, sum-of-parts valuation, and deeper multiples analysis. A strong Level 1 foundation — especially when paired with Portfolio Management concepts like CAPM — makes the transition manageable.
Study Strategy That Delivers Results
Master the Gordon Growth Model cold
The DDM and specifically the Gordon Growth Model (P = D1 / (r - g)) is the most frequently tested formula in Equity. You need to be able to:
- Calculate the value given inputs
- Solve for the implied required return
- Solve for the implied growth rate
- Understand what happens when growth rate approaches the required return
Spend extra time here. This formula and its variations account for a disproportionate number of exam questions.
Understand when each valuation model is appropriate
The exam doesn’t just ask you to calculate — it asks you to choose the right model. Key principles:
- DDM works best for stable, dividend-paying companies
- P/E is most useful when earnings are positive and relatively stable
- P/B is useful for capital-intensive industries and financial firms
- EV/EBITDA is useful for comparing companies with different capital structures
- FCFE/FCFF is preferred when dividends don’t reflect the company’s capacity to pay
This “model selection” skill is tested repeatedly. Make sure you can justify why one approach fits better than another for a given scenario.
Don’t neglect market structure
I’ve seen many candidates focus almost entirely on valuation and neglect the market structure readings. This is a mistake — those readings offer some of the easiest questions on the exam, and they don’t require complex calculations.
Connect Equity to FRA
Equity analysis is fundamentally about interpreting financial statements. If you’ve studied FRA well, you’ll find that analyzing companies for equity valuation feels natural. The ratios you learned in FRA are the same ratios you’ll use to assess equity value.
Common Mistakes That Cost Marks
Mistake 1: Using the wrong dividend in the Gordon Growth Model. The formula uses D1 (next year’s dividend), not D0 (the most recent dividend). If the question gives you D0, you need to grow it by one period: D1 = D0 x (1 + g). This trips up candidates on almost every mock exam.
Mistake 2: Confusing trailing and forward P/E. Trailing P/E uses past 12 months’ earnings. Forward P/E uses expected next 12 months’ earnings. The question will specify which one to use — read carefully.
Mistake 3: Ignoring the assumptions behind valuation models. Every model has assumptions. The Gordon Growth Model assumes constant growth forever — which is unrealistic for high-growth companies. The exam tests whether you understand these limitations, not just the math.
Mistake 4: Confusing EV with market cap. Enterprise Value = Market Cap + Debt - Cash. EV-based multiples and equity-based multiples are not interchangeable. Using EBITDA with equity value (or earnings with enterprise value) is a conceptual error the exam deliberately tests.
Mistake 5: Misunderstanding market efficiency implications. If markets are semi-strong form efficient, fundamental analysis cannot generate excess returns. If markets are only weak-form efficient, technical analysis fails but fundamental analysis might work. These logical implications get tested in subtle ways.
Practical Exam Tips
Tip 1: For DDM questions, always check whether you’re given D0 or D1. This single check can save you from the most common error in the Equity section.
Tip 2: When comparing valuation multiples across companies, check that they use consistent definitions. A P/E ratio using diluted earnings per share is not comparable to one using basic EPS.
Tip 3: Industry life cycle questions are usually qualitative. Don’t overthink them. Match the described characteristics (revenue growth, competition intensity, profitability) to the appropriate stage.
Tip 4: For market efficiency questions, focus on the implications for investment strategies. The exam cares less about the theory itself and more about what it means for practitioners.
Time Allocation
Budget 35-45 hours for Equity Investments. Break it down as:
- Market organization and structure: 6-8 hours
- Security market indices: 4-5 hours
- Industry and company analysis: 6-8 hours
- Equity valuation models: 12-15 hours
- Market efficiency: 4-5 hours
- Practice problems: 8-10 hours
Spend the bulk of your time on valuation models — they carry the most weight and offer the most complex questions.
Final Thoughts
Equity Investments is one of the most rewarding sections in the CFA Level 1 curriculum. It combines analytical rigor with real-world applicability in a way that few other sections do. If you approach it with genuine curiosity — not just a desire to pass — you’ll find that the concepts stick naturally.
The key is balancing breadth and depth. Cover all the topics (including the market structure readings that many candidates skip), but go deep on valuation models where the exam concentrates its toughest questions.
If you’re struggling with valuation concepts or want guidance on connecting Equity analysis to your career goals, reach out for a free mentorship session. Getting Equity right at Level 1 sets the tone for the entire CFA journey.