Noteworthy CFA® Level 1: Three-Step Approach to Stock Valuation

B

Although analysis of alternative countries and regions may be undertaken, that analysis is done under the more general step of analyzing the economy and security markets.

The top-down, three-step approach to stock valuation involves analyzing various factors in a hierarchical manner to arrive at an appropriate valuation. This approach starts with a broad analysis and gradually narrows down to specific individual firms and stocks. The three steps typically include the following:

1. Analysis of the economy and security markets: This step involves assessing the overall economic conditions and trends, as well as the state of the securities markets. Analysts examine macroeconomic indicators such as GDP growth, inflation rates, interest rates, and government policies. They also evaluate the performance of the overall stock market, bond market, and other asset classes. This analysis helps in understanding the broader market conditions and trends that can impact stock valuations.

2. Analysis of countries and regions: After understanding the macroeconomic conditions, the next step is to analyze different countries and regions. This step aims to identify countries or regions that offer favorable investment opportunities based on factors such as economic growth prospects, political stability, legal frameworks, infrastructure development, and market regulations. Analysts consider various factors specific to each country or region that could impact the valuation of stocks.

3. Analysis of individual firms and stocks: The final step in the top-down, three-step approach involves analyzing individual firms and stocks. Once the macroeconomic and country-level analysis is completed, analysts focus on specific industries and companies within those industries. They evaluate the fundamental factors such as financial statements, competitive positioning, management quality, growth prospects, and valuation metrics of individual firms. This analysis helps in determining the intrinsic value of stocks and making investment decisions.

Based on the given options, the answer is A. Analysis of alternative industries. This is because the top-down, three-step approach primarily focuses on macroeconomic factors, countries/regions, and individual firms/stocks. While alternative industries may be considered during the analysis of individual firms, it is not specifically mentioned as one of the three steps in the top-down approach.