Overview
Equity Investments is 11-14% of the CFA Level 1 exam, one of the three heaviest topics. It has three areas. Markets, indexes and efficiency cover how securities markets work, the purpose and construction of market indexes, and market efficiency (the forms of the efficient market hypothesis and their implications). Equity securities and analysis cover the types and features of equity (common and preferred shares, depositary receipts), and the frameworks for industry and company analysis (competitive analysis, such as Porter's five forces, and forecasting). Equity valuation covers the main valuation models: present value (dividend discount) models, multiplier (price-to-earnings and other multiples) models, and asset-based valuation.
The exam rewards understanding how markets and indexes work, the implications of market efficiency, how to analyze an industry and company, and how to apply the valuation models, especially the dividend discount model and price multiples. It overlaps heavily with financial statement analysis and corporate issuers.
How it's tested
CFA Level 1 Equity Investments questions test market mechanics, efficiency, company analysis, or a valuation calculation. CFA Level 1 questions are multiple choice with three options, mixing concept recall with calculations, so read for the specific concept or formula being tested and work the computation carefully where required.
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Markets and efficiency
A market or efficiency situation is described, and you apply the index or efficient-market concept.
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Analyze the company
An industry or company situation is described, and you apply the analysis framework.
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Value the equity
A valuation situation is described, and you apply the dividend discount model, a multiple, or asset-based valuation.
An analyst finds that a stock's price fully and instantly reflects all publicly available information, so studying public financial statements provides no edge, yet private information could. This describes the semi-strong form of market efficiency: prices reflect all public information, so fundamental analysis of public data cannot consistently earn abnormal returns, while only material private information could. Identifying this as semi-strong-form efficiency is what the exam expects, distinct from weak form (past prices only) and strong form (all information).
Topic areas 3
Official topic areas from the CFA Institute outline, in outline order.
6.1 Markets, indexes, and market efficiencyMarket structure, indexes, and the efficient market hypothesis.
- What it means
- This covers how securities markets are organized and function, the purpose and construction of market indexes (including weighting methods: price-weighted, market-capitalization-weighted, equal-weighted), and market efficiency, the three forms of the efficient market hypothesis (weak, semi-strong, strong) and their implications for active management.
- What to understand
- Indexes represent markets and differ by weighting: price-weighted (like the Dow), cap-weighted (most common), and equal-weighted. Market efficiency describes how fully prices reflect information: weak form (past prices), semi-strong form (all public information), and strong form (all information, public and private). The more efficient the market, the harder to earn abnormal returns. Knowing index construction and the efficiency forms is tested.
- How it shows up
- A market or efficiency situation is described, and you must identify the index method or the efficiency form.
- Common confusion
- Confusing the index weighting methods, or the three forms of market efficiency.
6.2 Equity securities and industry and company analysisEquity types and the analysis frameworks.
- What it means
- This covers the types and features of equity securities (common and preferred shares, their rights and risk, and depositary receipts for foreign shares), and the frameworks for industry and competitive analysis (such as Porter's five forces) and company analysis (business model, competitive position, and forecasting past, present and future).
- What to understand
- Common stock carries voting and residual claims, while preferred has priority and usually a fixed dividend. Industry analysis assesses the attractiveness and competitive dynamics of an industry (Porter's five forces: rivalry, new entrants, substitutes, buyer and supplier power), and company analysis evaluates the firm's position and forecasts its performance. Knowing the equity types and the analysis frameworks is tested.
- How it shows up
- An equity-type or analysis situation is described, and you must identify the security feature or apply the framework.
- Common confusion
- Confusing common and preferred stock features, or misapplying the industry-analysis framework.
6.3 Equity valuation modelsPresent value, multiplier, and asset-based valuation.
- What it means
- This covers the main equity valuation approaches: present value (dividend discount) models, including the Gordon growth model that values a stock as dividends growing at a constant rate discounted at the required return; multiplier models using price multiples such as price-to-earnings; and asset-based valuation using the value of the firm's net assets.
- What to understand
- The dividend discount model values equity as the present value of expected dividends; the Gordon growth model simplifies this for constant growth (value equals next dividend divided by required return minus growth). Multiples compare price to a fundamental like earnings. Asset-based valuation uses net asset value. Each fits different situations. Knowing how to apply the models, especially the Gordon growth model and P/E, is heavily tested.
- How it shows up
- A valuation situation is described, and you must apply the dividend discount model, a multiple, or asset-based valuation.
- Common confusion
- Misapplying the Gordon growth model (for example, using the current rather than next dividend), or confusing the valuation approaches.
High-yield concepts
The terms, rules and formulas this domain turns into questions most often.
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Index weighting
Price, cap, or equal-weighted.
- Remember
- Cap-weighted is most common.
- Tested as
- Index questions.
- Trap
- Confusing the methods.
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Weak-form efficiency
Prices reflect past prices.
- Remember
- Technical analysis cannot beat it.
- Tested as
- Efficiency questions.
- Trap
- Confusing with semi-strong.
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Semi-strong-form efficiency
Prices reflect all public information.
- Remember
- Fundamental analysis cannot beat it.
- Tested as
- Efficiency questions.
- Trap
- Confusing the forms.
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Strong-form efficiency
Prices reflect all information.
- Remember
- Even private information.
- Tested as
- Efficiency questions.
- Trap
- Confusing with semi-strong.
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Common vs. preferred stock
Voting residual versus fixed priority.
- Remember
- Different rights and risk.
- Tested as
- Equity questions.
- Trap
- Confusing the two.
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Depositary receipts
Represent foreign shares.
- Remember
- Let investors hold foreign equity.
- Tested as
- Equity questions.
- Trap
- Confusing with domestic shares.
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Porter's five forces
Industry competitive analysis.
- Remember
- Rivalry, entrants, substitutes, buyer/supplier power.
- Tested as
- Analysis questions.
- Trap
- Misapplying the framework.
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Dividend discount model
PV of expected dividends.
- Remember
- Values equity from dividends.
- Tested as
- Valuation questions.
- Trap
- Misapplying it.
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Gordon growth model
Constant-growth dividend model.
- Remember
- Value = D1 / (r - g).
- Tested as
- Valuation questions.
- Trap
- Using the current dividend.
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Price multiples
Price-to-earnings and others.
- Remember
- Compare price to a fundamental.
- Tested as
- Valuation questions.
- Trap
- Misusing the multiple.
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Required return
The discount rate for equity.
- Remember
- Often from the CAPM.
- Tested as
- Valuation questions.
- Trap
- Confusing with growth.
Side by side
Concepts candidates mix up, compared on the point that decides the answer.
Forms of market efficiency
| Concept | Meaning | Key difference | Common trap |
|---|---|---|---|
| Weak form | Reflects past prices | Technical analysis fails | Confusing with semi-strong |
| Semi-strong form | Reflects all public info | Fundamental analysis fails | Confusing the forms |
| Strong form | Reflects all info | Even private info | Confusing with semi-strong |
Index weighting methods
| Concept | Meaning | Key difference | Common trap |
|---|---|---|---|
| Price-weighted | Weighted by share price | Like the Dow | Confusing with cap-weighted |
| Cap-weighted | Weighted by market cap | Most common | Confusing with equal-weighted |
| Equal-weighted | Each stock equal | Needs rebalancing | Confusing with cap-weighted |
Valuation approaches
| Concept | Meaning | Key difference | Common trap |
|---|---|---|---|
| Dividend discount | PV of dividends | Gordon growth for constant growth | Using current dividend |
| Multiples | Price relative to a fundamental | P/E and others | Misusing the multiple |
| Asset-based | Net asset value | For asset-heavy firms | Misapplying it |
Exam traps
Each trap is an answer that looks right. Learn the clue that should change your mind.
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Semi-strong is weak form
- What candidates pick
- Call a market where prices reflect all public information weak-form efficient.
- Why it looks right
- Both are efficiency forms.
- Why it's wrong
- Weak form reflects only past prices; semi-strong form reflects all public information, so fundamental analysis of public data cannot earn abnormal returns.
Clue to watch for Prices reflect all public, not just past-price, information.
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Gordon model with current dividend
- What candidates pick
- Value a stock as the current dividend divided by (required return minus growth).
- Why it looks right
- The dividend is known.
- Why it's wrong
- The Gordon growth model uses next year's dividend (D1), the current dividend grown one period, in the numerator.
Clue to watch for The model needs the expected (next) dividend.
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Price-weighted is cap-weighted
- What candidates pick
- Treat a price-weighted index as reflecting company size.
- Why it looks right
- Both weight stocks.
- Why it's wrong
- Price-weighted indexes weight by share price (so a high-priced small company can dominate); cap-weighted indexes weight by market capitalization.
Clue to watch for The index is weighted by price versus market cap.
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Preferred stock votes
- What candidates pick
- Assume preferred shareholders have full voting rights like common.
- Why it looks right
- Both are equity.
- Why it's wrong
- Preferred stock typically has a fixed dividend and priority over common but usually no voting rights; common carries the vote and residual claim.
Clue to watch for The question asks about voting rights.
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Efficient market, active management wins
- What candidates pick
- Expect active fundamental analysis to beat a semi-strong-efficient market consistently.
- Why it looks right
- Analysis seems valuable.
- Why it's wrong
- In a semi-strong-efficient market, public information is already in prices, so fundamental analysis cannot consistently earn abnormal returns.
Clue to watch for The market reflects all public information.
Answer framework
For any Equity Investments question, use these steps to find the answer the exam expects.
- Identify whether the question is about markets and efficiency, company analysis, or valuation.
- For efficiency, match the situation to the form: weak (past prices), semi-strong (all public information), or strong (all information), and know index weighting methods.
- For analysis, apply industry frameworks like Porter's five forces and company analysis, and distinguish common from preferred equity.
- For valuation, apply the dividend discount (Gordon growth) model using next year's dividend, price multiples, or asset-based valuation as appropriate.
- Choose the analytically correct answer, using the required return as the discount rate and the right model for the situation. Where two options seem to fit, choose the one that most precisely applies the CFA concept, formula or standard the question is testing.
Practice question
Want more like this? The CFA Level 1 practice test has questions for every domain.
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Study strategy
Give this heavy topic strong study time, since at 11-14% it is one of the largest and central to the profession. Start with markets and efficiency: the index weighting methods and especially the three forms of the efficient market hypothesis (weak, semi-strong, strong) and what each implies for beating the market, which is heavily tested.
Then learn equity securities (common versus preferred, depositary receipts) and the analysis frameworks, especially Porter's five forces for industry analysis. Master the valuation models, which carry the calculations: the dividend discount and Gordon growth model (using next year's dividend), price multiples like P/E, and asset-based valuation.
Because valuation builds on financial statement analysis and the cost of capital from corporate issuers, study those together, and practice valuation calculations with the financial calculator. Because CFA Level 1 mixes concepts with calculations, practice the formulas by hand with a financial calculator, drill large question banks by topic, and take full mock exams to build speed and stamina across all ten topics. Afterwards, move to Fixed Income.
FAQ
How much of CFA Level 1 is Equity Investments?
Equity Investments is 11-14% of the exam, one of the three heaviest topics, covering markets, efficiency, company analysis and valuation.
What are the three forms of market efficiency?
Weak form (prices reflect all past price and volume data, so technical analysis cannot consistently beat the market), semi-strong form (prices reflect all public information, so fundamental analysis of public data cannot beat the market), and strong form (prices reflect all information, public and private).
How do index weighting methods differ?
Price-weighted indexes weight each stock by its share price (so high-priced stocks dominate), market-capitalization-weighted indexes weight by company size (the most common method), and equal-weighted indexes give each stock the same weight and require regular rebalancing.
What is the Gordon growth model?
A dividend discount model for a stock whose dividends grow at a constant rate. It values the stock as next year's dividend divided by the required return minus the growth rate. A common error is using the current dividend instead of next year's expected dividend.
What is the difference between common and preferred stock?
Common stock carries voting rights and a residual claim on assets and earnings, with variable dividends. Preferred stock typically pays a fixed dividend and has priority over common for dividends and in liquidation, but usually no voting rights.
What is Porter's five forces?
A framework for analyzing an industry's competitive intensity and attractiveness through five forces: rivalry among existing competitors, threat of new entrants, threat of substitutes, bargaining power of buyers, and bargaining power of suppliers.
How does Equity Investments connect to the rest of the exam?
Equity valuation uses the financial statements from financial statement analysis and the cost of capital from corporate issuers, and the efficiency and market concepts relate to portfolio management, so equity ties several topics together.
Other Finance certifications
Where the same subject shows up in other exams. Cards marked "Same subject" open the matching domain.
Test your Domain 6 knowledge
You have covered markets, efficiency, company analysis and valuation. Test whether you can analyze and value equities under exam conditions.
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