Equity valuation is the art of estimating what a share of stock is worth, separately from what it currently costs. Two analytic schools tackle the problem from opposite directions. Fundamental analysis examines what the company produces, earns, and owns — if intrinsic value exceeds market price, the stock is a buy. Technical analysis ignores the company entirely and looks at price and volume patterns — charts are the only input, and the past is the guide to the future. The Series 66 expects you to recognize each approach's vocabulary, know the major valuation ratios used in fundamental analysis, and understand how market-efficiency theory shapes whether either approach can systematically win.
There are two primary schools of thought for valuing stocks, and the Series 66 tests both at a conceptual level. The next two sections introduce them — fundamental analysis (looking at the underlying business) and technical analysis (looking at price and volume patterns) — before §3 develops the fundamental ratio toolkit, §4 covers the technical analysis vocabulary, and §5 closes with the Efficient Market Hypothesis framework that determines whether either approach can systematically work.
Fundamental analysis — the intrinsic-value approach
Fundamental analysis estimates a stock's intrinsic value by examining the underlying business: what the company produces, what it earns, what it owns, what management is doing, and where the industry is going. The premise is that markets misprice stocks — sometimes too high, sometimes too low — and disciplined analysis of the underlying business can identify those discrepancies.
Four families of fundamental tools, all rooted in financial statements and business analysis:
Earnings analysis — current and projected EPS, growth rates, "quality of earnings" (recurring vs. one-time, cash-backed vs. accounting-driven).
Valuation ratios — P/E, P/B, P/S, PEG, EV/EBITDA, dividend yield. Each captures a different angle on the price/fundamental relationship.
Discounted cash flow (DCF) models — estimating intrinsic value as the present value of expected future cash flows, just like a bond.
Dividend discount models (DDM) — a DCF specialized for stocks that pay regular dividends; equates intrinsic value to the present value of all future dividends.
Fundamental analysis is the dominant approach in long-horizon investing. Mutual fund managers, pension funds, and most professional investors are fundamentally-oriented. The horizon is typically months to years — long enough for the market to "recognize" the underlying value the analyst identified.
Technical analysis — the price-and-volume approach
Technical analysis ignores the underlying business entirely. The only inputs are price and volume data, and the only outputs are forecasts about where price is going next. The premise is that markets are driven by human psychology, and psychology produces patterns — recurring behaviors visible in price charts that signal future moves.
Three core technical claims:
Price discounts everything. Whatever's relevant about the company — earnings, sentiment, news, insider buying — is already reflected in the current price. The technician needs only the price chart.
Prices move in trends. Once a trend establishes, it tends to persist until visible evidence of reversal. Trading with the trend is more likely to win than trading against it.
History repeats. The same patterns — head and shoulders, double tops, golden crosses — appear across different stocks, time periods, and markets because they reflect persistent human behavior.
Technical analysis is the dominant approach in short-horizon trading. Day traders, swing traders, and most algorithmic strategies rely on technical signals. The horizon is typically days to weeks — short enough that fundamentals haven't changed but technical conditions have.
Fundamental and technical analysis — the two approaches
Fundamental analysis evaluates a company's intrinsic value by examining financial statements, management, competitive advantages, and industry conditions. Key tools include earnings analysis (EPS growth, quality of earnings), financial ratios (P/E, P/B, debt-to-equity), discounted cash flow (DCF) models, and the dividend discount model (DDM).
Technical analysis studies price and volume patterns to predict future price movements. Key concepts include charts and trend lines (support and resistance levels), moving averages, volume patterns, and chart-formation pattern recognition. Technical analysis does not consider a company's financials — only what the market is doing with the stock.
Fundamental vs. technical — side by side
Fundamental analysis
Focus
What the stock is worth (intrinsic value)
Key inputs
Financial statements, earnings, ratios, management, industry conditions
Time horizon
Long-term (months to years)
Core belief
Markets misprice stocks; research can identify bargains
Vocabulary
EPS, P/E, P/B, DDM, DCF, book value
EMH alignment
Challenges semi-strong form (public info can find bargains)
History repeats; price patterns predict future movements
Vocabulary
Support, resistance, moving averages, head and shoulders, volume
EMH alignment
Challenges weak form (past prices predict future prices)
Concept Check
A technical analyst evaluating a stock would MOST likely focus on:
Technical analysts study price and volume patterns to predict future price movements — they do not consider the underlying company's financial fundamentals. Support and resistance levels, trend lines, moving averages, and chart patterns are the core technical analysis tools. Earnings analysis, balance sheet data, and DDM intrinsic-value calculations all belong to fundamental analysis, which technical analysts dismiss as already-priced-in information. The Series 66 tests whether you can classify the analytic approach by the vocabulary used in the question.
Concept Check
Which of the following is a tool of fundamental analysis rather than technical analysis?
Discounted cash flow valuation is a core fundamental-analysis tool — it estimates intrinsic value by discounting expected future cash flows (operating cash flow, free cash flow to equity, or dividends) at the investor's required return. Moving average crossovers, chart patterns like head and shoulders, and support/resistance levels are all technical analysis tools — they rely on price and volume data, not the company's underlying financials or business prospects. The Series 66 tests the dichotomy directly: if the input is a financial-statement or business-model number, it's fundamental; if the input is price or volume data, it's technical.
Concept Check
The typical time horizon of fundamental analysis differs from that of technical analysis primarily in that fundamental analysis is:
Fundamental analysis typically uses a long-term horizon — months to years — because intrinsic value is established through underlying business performance that takes time to play out in market prices. Technical analysis is typically short-to-medium-term oriented (days to weeks) because chart patterns and momentum signals reflect near-term sentiment. Both approaches are used by retail and professional investors. Fundamental analysis is not restricted to dividend payers (DCF and free cash flow models work for non-dividend payers). Neither approach is inherently more 'precise' than the other — both rely on assumptions, just different kinds.
Section 2 of 5~9 min · 3 concept checks
Discounted cash flow & DDM
Discounted cash flow for equity
Discounted cash flow (DCF) is the most general fundamental-valuation framework. The intrinsic value of a stock equals the present value of all the future cash flows the shareholder expects to receive, discounted at the investor's required return:
Intrinsic Value = Σ [ Cash Flowt ÷ (1 + r)t ]
The framework is identical to bond valuation but the inputs are harder to nail down. For a bond, the cash flows are contractually fixed; for a stock, they have to be estimated. Two main DCF variants apply to equity:
Free Cash Flow to Equity (FCFE) model. Discounts the cash flow available to shareholders after the company has paid all operating expenses, interest, taxes, capital expenditures, and required debt repayments. Applies to dividend-paying and non-dividend-paying stocks alike.
Dividend Discount Model (DDM). A specialized DCF for dividend-paying stocks: intrinsic value equals the present value of all expected future dividends. Covered next.
DCF outputs are sensitive to the discount rate (small changes produce big swings in value) and to the assumed long-run growth rate. The Series 66 doesn't ask you to compute a multi-year DCF, but it expects you to recognize the framework and to understand that DCF value is the sum of discounted cash flows — the same logic that drove fixed-income pricing.
Dividend Discount Model variants
The DDM family covers three valuation approaches depending on how the dividend is expected to grow.
Zero-growth DDM
V = D ÷ r
Used for preferred stock and stable utilities where the dividend is fixed forever. Same formula as perpetuity.
Constant-growth DDM (Gordon Growth)
V = D1 ÷ (r − g)
Most-tested variant. Assumes dividends grow at a constant rate forever. Requires g < r or value goes infinite/negative.
Multi-stage DDM
Sum of high-growth period + terminal value
More realistic: high growth for first 5-10 years, then constant terminal growth. Used for fast-growing companies.
The Gordon Growth model is the dominant exam form. Recall what the variables mean:
D1 = the dividend expected to be paid next year (D0 × (1 + g), where D0 is the current annual dividend).
r = the investor's required return (the discount rate). Higher r → lower intrinsic value.
g = the assumed constant dividend growth rate. Higher g → higher intrinsic value. Must be less than r.
The intuition is straightforward: a stock paying growing dividends is worth more today (lower discounted denominator), and a stock requiring a higher return is worth less today (higher discount rate).
Worked example — Gordon Growth DDM
Apply the constant-growth DDM to a stock currently paying a $2.00 annual dividend, with dividends expected to grow at 5% per year. The investor's required return is 10%.
D0 (current dividend)
$2.00 per share annually
D1 (next year)
$2.00 × 1.05 = $2.10
g (growth rate)
5%
r (required return)
10%
Intrinsic value
V = $2.10 ÷ (0.10 − 0.05) = $2.10 ÷ 0.05 = $42.00
If the stock is currently trading at $35, the DDM suggests it is undervalued ($35 < $42 intrinsic value) and would be a buy. If it's trading at $50, it's overvalued and would be a sell or hold-only.
Limitations to remember. The Gordon Growth model only works for dividend-paying stocks (no use for Amazon, Berkshire, or growth tech), requires a constant growth assumption (unrealistic for most companies), and breaks down mathematically if g ≥ r (denominator goes to zero or negative). The interactive in section 2.3 lets you push the assumptions and see the model break.
DDM scenarios calculator
Set the current annual dividend, growth rate, and required return. The calculator computes the Gordon Growth intrinsic value and shows the sensitivity curve as growth rate varies.
Next year's dividend D1
$2.10
D0 × (1 + g)
Intrinsic value
$42.00
D1 ÷ (r − g)
Implied dividend yield
5.00%
D1 ÷ intrinsic value
The curve illustrates why the Gordon Growth model breaks down as g approaches r — the denominator (r − g) shrinks toward zero and intrinsic value explodes. The model only works when g is meaningfully below r.
Concept Check
Using the constant-growth dividend discount model, if a stock's required return (r) increases while the dividend growth rate (g) remains constant, the calculated intrinsic value will:
In the constant-growth DDM formula V = D₁ ÷ (r − g), an increase in r with g unchanged makes the denominator (r − g) larger, which makes the calculated intrinsic value smaller. The economic intuition: a higher required return means investors demand more compensation for holding the stock, so they're willing to pay less for the same expected dividend stream. The value doesn't go negative or stay constant — it simply shrinks. This is the same mechanic that drives bond prices down when yields rise: the discount rate in the denominator does the work.
Concept Check
Using the constant-growth DDM, calculate the intrinsic value of a stock currently paying a $1.50 annual dividend, with dividends expected to grow at 4% per year, when the investor's required return is 9%:
Gordon Growth DDM: V = D₁ ÷ (r − g). First compute next year's dividend: D₁ = $1.50 × (1 + 0.04) = $1.56. Then divide by the denominator (r − g) = (0.09 − 0.04) = 0.05. Intrinsic value = $1.56 ÷ 0.05 = $31.20. The most common mistake is using D₀ ($1.50) instead of D₁ ($1.56) in the numerator — the formula calls for next year's expected dividend, not the current dividend. Multiplying D₀ by (1 + g) gives D₁, then dividing by (r − g) gives the intrinsic value. The answer is $31.20.
Concept Check
A discounted cash flow (DCF) valuation of common stock estimates intrinsic value as:
Discounted cash flow valuation defines intrinsic value as the present value of all expected future cash flows discounted at the investor's required return — the same general framework that values a bond, applied to a stock's harder-to-estimate cash flows. The dividend discount model (DDM) is a specialized DCF where the cash flows are dividends. Free cash flow to equity models discount the cash available to shareholders after operating expenses and debt obligations. Book value, comparable ratios, and enterprise value are different valuation approaches — not DCF.
Section 3 of 5~9 min · 3 concept checks
Equity valuation ratios
P/E ratio — the most common multiple
The price-to-earnings ratio expresses what investors are paying today for each dollar of the company's current earnings:
P/E = Price per share ÷ Earnings per share (EPS)
Two flavors:
Trailing P/E uses the most recent 12 months' actual EPS. Backward-looking, based on real reported numbers. Conservative.
Forward P/E uses estimated EPS for the next 12 months. Forward-looking, depends on analyst forecasts. Often lower than trailing P/E for growing companies.
How to interpret a P/E ratio:
Higher P/E → investors are paying more per dollar of earnings, often because of expected growth, competitive moats, or low perceived risk. Tech and pharma typically trade at high P/Es.
Lower P/E → investors are paying less per dollar of earnings, often because of slow growth, cyclical earnings, or perceived risk. Utilities and mature industrial sectors typically trade at lower P/Es.
P/E only meaningful when compared — to the same company's history, to industry peers, or to the broader market. An "absolute" P/E like 18 means nothing without context.
Limitations: P/E is undefined when earnings are negative (loss-making companies); it's distorted by one-time items (charges, asset sales); and it ignores capital structure (a debt-heavy firm and a debt-free firm can have identical P/Es with very different risk).
PEG ratio and earnings yield
Two refinements of P/E that the Series 66 expects you to know:
PEG ratio — P/E adjusted for growth
PEG = P/E ÷ Expected EPS growth rate (in %)
A P/E of 20 looks expensive but isn't if the company is growing earnings at 25% per year (PEG = 0.8). A P/E of 12 looks cheap but isn't if growth is only 4% per year (PEG = 3.0). PEG below 1.0 is generally considered attractive; PEG above 2.0 suggests overvaluation relative to growth. The PEG ratio attempts to neutralize the issue that growing companies "deserve" higher P/Es.
Earnings yield — the inverse of P/E
Earnings yield = EPS ÷ Price = 1 ÷ P/E
Expresses earnings as a percentage yield comparable to bond yields. A stock with P/E of 20 has an earnings yield of 5%; with P/E of 10, the earnings yield is 10%. Useful when comparing stocks vs. bonds: if Treasury yields are 4% and a stock's earnings yield is 7%, the stock offers a "spread" of 3% over the risk-free rate — the equity risk premium implicit in the price.
P/B, P/S, EV/EBITDA, and dividend yield
Beyond the P/E family, four ratios handle valuation cases where earnings-based multiples fall short.
Price-to-Book (P/B) = Price per share ÷ Book value per share. Compares market price to accounting net worth. P/B near or below 1.0 historically signaled value; financials and capital-intensive industries trade at the lowest P/Bs. Distortions: intangible assets (patents, brands, software) often aren't on the balance sheet, so software companies with valuable IP show artificially high P/Bs.
Price-to-Sales (P/S) = Price per share ÷ Revenue per share. Useful when earnings are negative or volatile (early-stage tech, biotech, turnaround stocks). Revenue is harder to manipulate than earnings. Low P/S can flag value, but high P/S in fast-growing companies isn't necessarily expensive.
EV/EBITDA = Enterprise value ÷ Earnings before interest, taxes, depreciation, and amortization. Enterprise value = market cap + debt − cash. EBITDA approximates operating cash flow. EV/EBITDA neutralizes capital-structure differences (debt vs. equity) and depreciation choices — useful for comparing companies in capital-intensive industries (cable, telecom, energy).
Dividend yield = Annual dividend per share ÷ Price per share. Cash income the stock pays as a percentage of price. High dividend yields in stable companies signal value or expected future stress; low yields in fast-growing companies are normal because earnings get reinvested instead of paid out.
No single ratio dominates — analysts use multiples in combination, with industry context, to triangulate value.
Which ratio for which situation
P/E
Default multiple for profitable, stable-earnings companies. Useless if earnings are negative or one-time-distorted.
Capital-intensive industries (banks, insurance, REITs, industrials). Distorted by intangibles.
P/S
Loss-making or volatile-earnings companies (biotech, early-stage tech, cyclicals at trough).
EV/EBITDA
Cross-capital-structure comparison (cable, telecom, M&A targets). Neutralizes debt and depreciation.
Dividend yield
Income-oriented suitability (retirees, dividend funds, REITs, utilities). Watch for unsustainably high yields.
Concept Check
A stock with a P/E ratio of 25 compared to its industry peers' average P/E of 15 MOST likely suggests that the stock:
A higher P/E than peers means investors are paying more per dollar of current earnings — typically because they expect higher future earnings growth, perceive lower risk, or see a durable competitive advantage. A premium P/E does NOT mathematically prove overvaluation — many sustained high-P/E stocks (growth companies with real moats) genuinely deserve their premium. Higher P/E does NOT mean higher absolute EPS (P/E divides price by EPS). And P/Es do not auto-converge to industry averages — they can persist at premium or discount levels for years. The Series 66 tests whether you treat P/E as one data point requiring context, not a verdict.
Concept Check
The PEG ratio is calculated by dividing a stock's P/E ratio by its expected earnings growth rate. A PEG ratio of 0.6 MOST likely suggests:
PEG = (P/E) ÷ (expected EPS growth rate). A PEG of 0.6 means the P/E is only 60% of the growth rate — for example, P/E of 18 with growth of 30% gives PEG of 0.6. Such ratios are generally considered attractive: the investor is paying a relatively low multiple given the growth they're getting. PEG below 1.0 is the classic 'growth at a reasonable price' threshold; above 2.0 typically signals overvaluation relative to growth. PEG is independent of dividend policy (it uses earnings, not dividends). The whole point of PEG is to adjust P/E for growth differences so the multiple-vs-growth question is captured in a single number.
Concept Check
An adviser is evaluating an early-stage biotech company that has consistently reported negative earnings while growing revenues at 40% per year. The MOST appropriate valuation multiple for this company is:
Price-to-Sales is the standard multiple for companies with negative or volatile earnings. P/E is mathematically undefined when earnings are negative. PEG inherits the same problem — it requires P/E in the numerator. EV/EBITDA assumes positive EBITDA, which loss-making early-stage companies also lack. Revenue, by contrast, is positive and growing, making P/S the only multiple that produces a usable number. The Series 66 tests this scenario specifically: when earnings are negative or unreliable (biotech, early-stage tech, cyclicals at trough), shift to revenue-based or asset-based valuation rather than earnings-based metrics.
Section 4 of 5~7 min · 3 concept checks
Technical analysis
Charts and trends
Technical analysts work primarily from price charts. Three chart types are standard:
Line charts — closing prices connected by a line. Simplest; useful for seeing long-term trend direction.
Bar charts — each bar shows open, high, low, and close (OHLC) for the period. Standard professional format.
Candlestick charts — same OHLC data as bar charts but with a colored "body" between open and close. Originated in Japanese rice trading; the most popular format among modern technicians because patterns are visually distinctive.
The first thing a technician identifies is the trend:
Uptrend — series of higher highs and higher lows. Trade with the trend (buy pullbacks).
Downtrend — series of lower highs and lower lows. Trade with the trend (short rallies, or avoid long positions).
Sideways / range-bound — price oscillates between roughly stable upper and lower bounds. Trade the range (buy support, sell resistance).
Trend lines are drawn connecting consecutive lows (in uptrends) or consecutive highs (in downtrends). A break below an uptrend line or above a downtrend line is interpreted as a possible trend-reversal signal.
Support, resistance, and chart patterns
Support is a price level where buying interest has historically been strong enough to halt a price decline. Resistance is a level where selling interest has historically halted a price advance. Both levels become more significant the more times price has bounced off them.
Support broken → bearish signal. A previous support level often becomes new resistance once broken (psychology shift: former buyers become trapped sellers).
Resistance broken → bullish signal. A previous resistance level often becomes new support after a breakout (former sellers regret missed gains and buy on pullbacks).
Common chart patterns the Series 66 expects you to recognize:
Head and shoulders — classic reversal pattern showing a peak (head) flanked by two lower peaks (shoulders). After the right shoulder forms and price breaks the "neckline," technicians expect a downtrend. The inverted version (bullish reversal) is a "head and shoulders bottom."
Double top / double bottom — reversal patterns showing two failed attempts to break above (or below) a level, followed by a trend change. Less reliable than head and shoulders but more common.
Triangles and flags — continuation patterns: price consolidates briefly inside a converging or parallel shape, then breaks out in the direction of the prior trend.
Cup and handle — bullish continuation pattern; a rounded "cup" formation followed by a small consolidation "handle" before a breakout.
Moving averages, volume, and indicator signals
A moving average smooths a noisy price series by averaging price over a rolling window of recent periods. Two variants:
Simple moving average (SMA) — arithmetic mean over the last N periods. A 50-day SMA averages the last 50 closes.
Exponential moving average (EMA) — weighted average that gives more weight to recent prices and less to old ones. More responsive than SMA.
Common periods are 20-day (short-term), 50-day (intermediate), and 200-day (long-term). Two classic crossover signals:
Golden cross — 50-day MA crosses above 200-day MA. Interpreted as a major bullish signal: short-term momentum has turned positive enough to drag the longer average up. Often marks the beginning of multi-month bull moves.
Death cross — 50-day MA crosses below 200-day MA. Interpreted as a major bearish signal: short-term momentum is now negative, and the longer trend is rolling over.
Volume is the technician's confirmation tool. A price breakout on heavy volume is more reliable than a breakout on light volume. Declining volume during a rally is interpreted as weakening conviction. Climactic high volume at major peaks or troughs often signals reversal.
Beyond MAs and volume, dozens of technical indicators exist (RSI for overbought/oversold readings, MACD for momentum, Bollinger Bands for volatility bands). The Series 66 doesn't test individual indicator formulas but expects recognition: anything based on price/volume math, not on company fundamentals, is technical.
Spotting the analysis approach from vocabulary
If a question mentions "support levels," "resistance levels," "head and shoulders," "moving averages," or "volume analysis," the answer involves technical analysis. If it mentions "earnings," "financial statements," "book value," "intrinsic value," or "DCF," it's fundamental analysis. The exam tests whether you can classify the approach — not whether you can actually draw a chart or read a balance sheet.
Concept Check
A 50-day moving average is calculated by:
A simple moving average (SMA) is the arithmetic mean of closing prices over a specified rolling window — for a 50-day SMA, the average of the most recent 50 closes. Each new trading day, the oldest price drops out and the newest price is added, so the average 'moves.' Moving averages smooth out short-term price noise to make trend direction clearer. They are not high-low ranges, scaled per-share calculations, or forecasts of future prices. Common windows: 20-day (short-term trend), 50-day (intermediate), and 200-day (long-term). The exponential moving average (EMA) is a variant that weights recent prices more heavily.
Concept Check
A stock that has repeatedly stalled at $50 and reversed downward each time it approached that level has $50 acting as:
A resistance level is a price at which selling interest has historically halted price advances. The stock approaching $50 and reversing each time is the textbook definition. Technicians typically view a clean break above resistance with high volume as a bullish breakout signal — the prior 'ceiling' has been overcome and former sellers often switch to buyers, creating new support at the previous resistance level. A support level is the opposite — where buyers prevent further declines. A trading band describes a range bounded by both support and resistance. Moving averages are technical indicators but not what the $50 level represents here.
Concept Check
A 'golden cross' in technical analysis occurs when:
A golden cross is one of the most-cited technical signals: the 50-day moving average (shorter-term) crosses ABOVE the 200-day moving average (longer-term). Technicians interpret this as short-term momentum gaining enough strength to drag the long-term trend upward, suggesting a sustained bullish move ahead. The reverse — 50-day crossing BELOW 200-day — is the 'death cross,' a bearish signal. Golden cross has nothing to do with absolute price highs, volume per se (volume is the confirmation), or P/E versus P/B ratios (which are fundamental, not technical).
Section 5 of 5~6 min · 2 concept checks
Efficient Market Hypothesis
The Efficient Market Hypothesis
The Efficient Market Hypothesis (EMH), developed by Eugene Fama, argues that stock prices fully reflect all available information — meaning systematic outperformance through analysis is impossible. EMH comes in three "forms," each making a successively stronger claim about what kinds of information are reflected.
Weak form
Past prices already priced in
Prices reflect all historical price and volume data. Implication: technical analysis cannot consistently outperform — the patterns are already priced. Fundamental analysis might still work.
Semi-strong form
All public information priced in
Prices reflect all publicly available information (financials, news, analyst reports, economic data). Implication: neither technical nor fundamental analysis can consistently outperform. Only insider info would help.
Strong form
All information priced in — including insider
Prices reflect all information, public and private. Implication: even insiders cannot consistently outperform. Generally considered too strong — insider-trading regulations exist precisely because insiders can profit.
Implications for investors:
If markets are weak-form efficient (a widely accepted minimum), technical analysis is wasted effort over the long run.
If markets are semi-strong-form efficient (the form most academics accept for major stocks), even fundamental analysis can't reliably win after costs — favoring passive, index-based investing.
If strong-form efficiency held, insider-trading prohibitions would be unnecessary. The persistence of insider profits suggests strong form does not hold.
Documented "anomalies" — the size effect, value premium, momentum, low-volatility — suggest markets aren't perfectly efficient even in semi-strong form. The active-vs-passive debate is essentially a question about how efficient markets really are.
Concept Check
If markets are weak-form efficient, the implication for investors is that:
Weak-form efficiency states that all historical price and volume data is already reflected in current prices, so technical analysis — which uses precisely that data — cannot consistently outperform. This is the WEAKEST of the three EMH forms and the most widely accepted (even most active managers concede weak-form efficiency for large liquid stocks). Weak-form does NOT rule out fundamental analysis (that's the semi-strong claim), does NOT prevent insider trading from being profitable (that's strong-form), and does NOT mean prices never deviate from intrinsic value (EMH never claims this). Map each implication to the correct EMH form.
Concept Check
Under the semi-strong form of the Efficient Market Hypothesis, which of the following types of analysis would be expected to consistently outperform a passive index strategy?
Semi-strong efficiency states that all publicly available information — financial statements, news, analyst reports, economic data, AND historical prices — is already reflected in current prices. The implication: neither technical analysis (ruled out by weak-form already) NOR fundamental analysis (which uses public financials) can consistently outperform a passive strategy. Only material non-public information could give an edge — which is what strong-form would also rule out. Semi-strong is the form most academic finance treats as the working baseline for large-cap stocks and is the foundation of the case for index investing.
SummaryCram aid & consolidated traps
Chapter summary
Exam essentials · cram aid
Fundamental analysis
Intrinsic value; long-term horizon
Technical analysis
Price/volume; short-term horizon
Gordon Growth
V = D1 ÷ (r − g); requires g < r
P/E ratio
Price ÷ EPS; only meaningful in comparison
PEG
P/E ÷ growth; <1 attractive
Earnings yield
EPS ÷ price = 1/(P/E)
P/S
For loss-making / volatile-earnings companies
EV/EBITDA
Neutralizes capital structure differences
Support/resistance
Broken support → new resistance (and vice versa)
Golden cross
50-day MA crosses ABOVE 200-day MA (bullish)
EMH weak form
Past prices priced in → technical useless
EMH semi-strong
All public info priced in → fundamental useless too
Common traps the exam plants
"A low P/E means a stock is undervalued." Not necessarily. Low P/E can signal either value or poor business prospects. P/E only carries meaning compared to peers, history, or the broader market.
"The Gordon Growth model can be used to value any stock." No — it only applies to dividend-paying stocks with stable growth. It breaks down completely when g ≥ r and isn't useful for high-growth or non-dividend payers.
"Technical analysis is supported by weak-form EMH." Backwards. Weak-form EMH says past prices are already priced in — meaning technical analysis cannot consistently work. Weak-form efficiency is the minimum claim against technical analysis.
"P/E ratio compares price to book value." P/E uses earnings; P/B uses book value. Two different ratios for different angles on valuation. The Series 66 will swap labels to test recognition.
"A golden cross is a bearish signal." Reversed. Golden cross (50-day MA crossing ABOVE 200-day MA) is bullish. Death cross (50-day BELOW 200-day) is bearish.
"Earnings yield is the same as dividend yield." No — earnings yield is EPS ÷ price (1/(P/E)). Dividend yield is annual dividends ÷ price. A company can have high earnings yield but low dividend yield if it reinvests most earnings rather than paying them out.
"Semi-strong EMH says insider trading is profitable." No — semi-strong says public info is priced in. Strong form is what would imply insiders can't profit. Insider-trading regulation suggests strong form does NOT hold in practice.