Learn how Series 86 tests P/E, EV-based metrics, dividend and cash-flow approaches, cost of capital, and recommendation logic.
Series 86 gives the candidate a broad valuation toolkit because no single method fits every company. The analyst is expected to know when a metric is useful, what it captures, what it can miss, and how it supports a recommendation. The exam therefore tests both formula familiarity and method selection.
At a high level, some methods focus on earnings, some on assets, some on cash generation, and some on enterprise-wide value relative to operating performance. The stronger answer usually matches the metric to the company’s economics instead of using a favorite ratio mechanically.
[ \text{P/E} = \frac{\text{Price per Share}}{\text{Earnings per Share}} ]
[ \text{EV} = \text{Equity Value} + \text{Debt} - \text{Cash} ]
[ \text{EV/EBITDA} = \frac{\text{Enterprise Value}}{\text{EBITDA}} ]
These formulas are simple, but the exam point is judgment. P/E can be useful when earnings are meaningful and comparable. EV-based measures can be more helpful when capital structure differs across peers. Dividend or discounted cash flow approaches may be more useful when cash-generation patterns and required returns matter more than near-term earnings optics.
| Valuation method | Best used when | Common Series 86 trap |
|---|---|---|
| P/E or normalized P/E | earnings are meaningful and comparable | using it on unstable or distorted earnings |
| P/B | book value matters economically | treating asset-heavy and asset-light firms the same |
| EV/EBITDA or EV/sales | leverage differs across peers or operating comparison matters | ignoring what EBITDA or sales fail to capture |
| dividend discount model | dividend stream is central to valuation | forcing it onto firms where dividends are not the main story |
| discounted cash flow | long-run cash generation is the key driver | assuming the result is precise when inputs are weak |
A stock does not become a buy simply because it trades below peers on one ratio. Series 86 expects the analyst to ask whether the lower multiple reflects weaker growth, higher risk, lower quality, more leverage, or a real opportunity. Likewise, a premium multiple may be justified if the company has stronger economics, better management execution, or more durable returns.
This is why the outline pairs valuation methods with recommendation determination. The valuation result has to be interpreted. It is not enough to compute a ratio and stop.
The outline also includes cost of capital, leverage, interest coverage, and related credit-sensitive measures because valuation should respond to risk, not just to growth. A company with attractive growth but a fragile balance sheet may deserve a lower multiple than a similar company with cleaner cash generation and less financing pressure.
Two companies produce similar operating profits, but one carries much more debt. Which valuation approach is generally stronger if the analyst wants to compare the businesses before financing effects?
A. P/E, because earnings always remove financing differences
B. EV/EBITDA, because enterprise value better captures the whole business across different capital structures
C. Dividend yield, because dividends neutralize leverage
D. Price-to-book, because book value ignores debt levels
Answer: B. Series 86 commonly favors EV-based comparison when leverage differences would distort equity-only measures like P/E.