EQUITY INVESTMENTS CHEAT SHEET

PORTER'S FIVE FORCES

Cue: Assess industry profitability and competitive intensity

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Rule: Weak all five forces → High sustainable margins (e.g., software, networks) Strong forces across multiple dimensions → Low industry profitability (e.g., airlines)

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INDUSTRY LIFE CYCLE STAGES

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Key: Life cycle stage determines competitive dynamics, capital intensity, and appropriate valuation multiples.

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COMPETITIVE ADVANTAGE (ECONOMIC MOAT) SOURCES

Cue: Identifies sustainable excess returns above cost of capital

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Key Metric: Competitive Advantage Period (CAP) = Years firm can sustain excess returns → directly impacts intrinsic value premium over book value

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FINANCIAL FORECASTING FOR DCF

Revenue Forecast:

Top-down: Industry size × Company market share

Bottom-up: Historical growth adjusted for industry/competitive factors

Operating Margin Projection:

Use industry benchmarks + company-specific cost structure

Account for operating leverage, scale effects

Terminal Value (Most Critical): $$\text{Terminal Value} = \frac{\text{Final Year FCF} \times (1 + g)}{WACC - g}$$

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Rule: Terminal value typically = 60–80% of total DCF value → Run sensitivity analysis on g and WACC

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INDEX WEIGHTING METHODOLOGIES

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Implication: Market-cap indices passively overweight stocks that have already rallied; equal-weighted indices provide rebalancing benefit but higher costs.

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HIGH-YIELD FORMULAS

$$\text{Market Cap} = \text{Price per Share} \times \text{Shares Outstanding}$$

$$\text{Revenue Growth (top-down)} = \text{Industry Growth} \times \text{Market Share Change}$$

$$\text{Terminal Value} = \text{FCF}_\text{final} \times \frac{1+g}{WACC - g}$$

$$\text{PV} = \frac{\text{Cash Flow}}{(1 + r)^n}$$

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EASILY-CONFUSED PAIRS

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Threat of New Entrants	Low barriers to entry	High barriers (scale, patents, capital, brand, switching costs)
Force	High = Bad For Profitability	Low = Good For Profitability
Supplier Power	Few suppliers, can raise prices	Many suppliers, fragmented
Buyer Power	Few large buyers, price sensitive	Fragmented buyers, low price sensitivity
Threat of Substitutes	Good substitutes available	Few/no substitutes
Competitive Rivalry	Many competitors, commoditized products	Few competitors, differentiated products
Stage	Growth	Competition	Margins	Valuation Approach
Embryonic	Slow, market developing	Few players, high failure risk	Low/negative	High growth assumptions, high risk
Growth	Rapid expansion	Increasing competitors attracted	Expanding	Higher multiples, reinvestment needs
Shakeout	Slowing growth	Intense, weaker players exit	Pressure	Risky; survivors have durable moats
Mature	Slow, stable (GDP-like)	Consolidated, stable rivalry	Stable	Modest multiples, focus on efficiency
Decline	Negative	Consolidation or exit	Compressed	Low multiples; terminal value near zero
Source	Definition	Example	Durability
Cost Advantages	Scale economies, proprietary tech, low-cost inputs	Intel chip manufacturing, Walmart sourcing	Medium-High
Intangible Assets	Patents, brands, licenses, regulatory approval	Pharma patents, branded pharmaceuticals	High if renewed/protected
Switching Costs	Customer lock-in (embedded software, loyalty)	Enterprise software, payment networks	High
Network Effects	Value increases with # users (two-sided markets)	Visa/Mastercard, LinkedIn, Uber	Very High
Efficient Scale	Natural monopoly in limited market	Regional utility, local telecom	High if uncontested
Assumption	Typical Range	Risk
Terminal growth rate (g)	2–3% GDP-like for mature	Overly optimistic g → inflates value
WACC	6–10% depending on risk	WACC changes dominate TV
Type	Weight by	Bias	Maintenance
Price-Weighted	Stock price per share	Favors high-priced stocks (unrelated to size); stock splits distort	Infrequent rebalancing
Market-Cap-Weighted	Market capitalization	Momentum bias (winners get heavier); concentration risk	Passive drift
Float-Adjusted	Tradeable shares only	More representative; excludes insider/gov blocks	Passive drift
Equal-Weighted	Same weight all constituents	Value tilt (rebalancing sells winners, buys losers)	Frequent rebalancing
Concept A	Concept B	Key Difference
Switching Costs	Network Effects	Switching: I'm locked in because leaving is painful. Network: System becomes more valuable as more users join.
Barriers to Entry	Competitive Advantage Period	Entry barriers: Why new competitors can't easily enter. CAP: How long incumbent can earn excess returns.
Price-Weighted Index	Equal-Weighted Index	Price: High-priced stock dominates (unrelated to size). Equal: All stocks same weight; requires active rebalancing.
Mature Stage	Declining Stage	Mature: Stable slow growth, consolidated structure. Declining: Negative growth, disruption or demand loss.

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EXAM QUICK HITS

✓ Patent cliff = pharmaceutical CAP terminus; triggers dramatic margin collapse ✓ Two-sided network effects (e.g., Visa

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