Equity Research Interview Questions

What are the most common equity research interview questions?

Based on our first-hand experience, as well discussions with equity research professionalsEquity Research AnalystAn equity research analyst provides research coverage of public companies and distributes that research to clients. We cover analyst salary, job description, we’ve compiled a list of the top questions to be asked by a research analyst when interviewing an associate. We’ve also added what we think are the best answers to these challenging interview questions.  Here are the top equity research interview questions and answers…

If you had $1 million to invest, what would you do with it?

Tell me about a company you admire and what makes it attractive.

Pitch me a stock (typically will be followed-up with a challenge – e.g., Why has the market not priced this in?)

These are all variants on one of the most common equity research interview questions – pitch me a stockStockWhat is a stock? An individual who owns stock in a company is called a shareholder and is eligible to claim part of the company’s residual assets and earnings (should the company ever be dissolved). The terms "stock", "shares", and "equity" are used interchangeably..  Be prepared to pitch three or four stocks – for example, a large cap stock, a small cap stock, and a stock that you would short.  For any company you are going to pitch, make sure that you have read a few analyst reports and know key information about the company.  You must know basic valuation metrics (EV/EBITDA multiples, PE multiples, etc.), key operational statistics, and the names of key members of the management team (e.g., the CEOCEOA CEO, short for Chief Executive Officer, is the highest-ranking individual in a company or organization. The CEO is responsible for the overall success of an organization and for making top-level managerial decisions. Read a job description).  You also must have at least three key points to support your argument.

How do you value a stock?

The most common valuation methodsValuation MethodsWhen valuing a company as a going concern there are three main valuation methods used: DCF analysis, comparable companies, and precedent transactions. These methods of valuation are used in investment banking, equity research, private equity, corporate development, mergers & acquisitions, leveraged buyouts and finance are DCF valuation methods and relative valuation methods using comparable public companies (“Comps”) and precedent transactions (“Precedents”).

Why might a high tech company have a higher PE than a grocery retailer?

It can also be shown that the Price-EarningsPrice Earnings RatioThe Price Earnings Ratio (P/E Ratio) is the relationship between a company’s stock price and earnings per share. It gives investors a better sense of the value of a company. The P/E shows the expectations of the market and is the price you must pay per unit of current (or future) earnings multiple is driven by (1 – g/ROE) / (r – g) where r is the cost of equity, g is the growth rate, and ROE is return on equityReturn on Equity (ROE)Return on Equity (ROE) is a measure of a company’s profitability that takes a company’s annual return (net income) divided by the value of its total shareholders' equity (i.e. 12%). ROE combines the income statement and the balance sheet as the net income or profit is compared to the shareholders’ equity..  A high tech company may have a higher PE because growth expectations for the stock are higher.

What drives the PB multiple? Or, why may two companies in the same industry have very different PB multiples?

The PB multiple can be shown to be PE x ROE.  It is therefore driven by return on equity and the drivers of the PE multiple.  It can also be shown that the PE multiple is driven by (1 – g/ROE) / (r – g) where r is the cost of equity, g is the growth rate, and ROEReturn on Equity (ROE)Return on Equity (ROE) is a measure of a company’s profitability that takes a company’s annual return (net income) divided by the value of its total shareholders' equity (i.e. 12%). ROE combines the income statement and the balance sheet as the net income or profit is compared to the shareholders’ equity. is return on equity.

Since the PB multiple is PE x ROE, this means the PB multiple is ( ROE – g ) / (r – g).  If we assume a zero growth rate, the equation implies that the market value of equity should be equal to the book value of equity if ROE = r.  The PB multiple will be higher than 1 if a company delivers ROE higher than the cost of equity (r).

Tell me when you would see a company with a high EV/EBITDA multiple but a low PE multiple.

This relationship implies a significant difference between the firm’s enterprise value and its equity value.  The difference between the two is “net debt”.  As a result, a company with a significant amount of net debt will likely have a higher EV/EBITDA multipleEBITDA MultipleThe EBITDA multiple is a financial ratio that compares a company's Enterprise Value to its annual EBITDA.  This multiple is used to determine the value of a company and compare it to the value of other, similar businesses. A company's EBITDA multiple provides a normalized ratio for differences in capital structure,.

What is a beta?

Beta is a measure of market (systematic) risk. Beta is used in the capital asset pricing model (CAPM)Capital Asset Pricing Model (CAPM)The Capital Asset Pricing Model (CAPM) is a model that describes the relationship between expected return and risk of a security. CAPM formula shows the return of a security is equal to the risk-free return plus a risk premium, based on the beta of that security to determine a cost of equity. Beta measures a stock’s volatility of returns relative to an index. So a beta of 1 has the same volatility of returns as the index, and a beta higher than 1 is more volatile.

Why do you unlever beta?

When you look up beta on BloombergBloomberg Functions ListList of the most common Bloomberg functions and shortcuts for equity, fixed income, news, financials, company information. In investment banking, equity research, capital markets you have to learn how to use Bloomberg Terminal to get financial information, share prices, transactions, etc. Bloomberg functions list, it’s levered to reflect the debt of each company. But each company’s capital structure is different and we want to look at how “risky” a company is regardless of what percentage of debt or equity it has. To get that, we need to unlever betaUnlevered Beta / Asset BetaUnlevered Beta (Asset Beta) is the volatility of returns for a business, without considering its financial leverage. It only takes into account its assets. It compares the risk of an unlevered company to the risk of the market. It is calculated by taking equity beta and dividing it by 1 plus tax adjusted debt to equity each time. You look up the beta for a group of comparable companies, unlever each one, take the median of the set, and then lever it based on your company’s capital structure. Then you use this Levered Beta in the Cost of Equity calculation. For your reference, the formulas for unlevering and re-levering Beta are below:

Unlevered Beta = Levered Beta / (1 + ((1 – Tax Rate) x (Total Debt/Equity)))
Levered Beta = Unlevered Beta x (1 + ((1 – Tax Rate) x (Total Debt/Equity)))

What’s the difference between enterprise value and equity value?

This question is commonly asked in banking, but could easily be one of the frequently asked equity research interview questions as well.  Enterprise valueEnterprise ValueEnterprise Value, or Firm Value, is the entire value of a firm equal to its equity value, plus net debt, plus any minority interest, used in valuation. It looks at the entire market value rather than just the equity value, so all ownership interests and asset claims from both debt and equity are included. is the value of the company that is attributable to all investors.  Equity value only represents the portion of the company belonging to shareholders.  Enterprise value incorporates the market value of the equity plus the market value of net debt (as well as other sources of funding, if used, such as preferred shares, minority interests, etc.).

Can a company have an equity value larger than its enterprise value?

Technically, yes.  Enterprise value is the sum of the market value of equity and net debt (gross debt less cash).  If a company has no interest bearing debt but does have cash, then it will lead to a situation where the equity value is greater than the enterprise value.

What are the major valuation methodologies?

• DCF valuation methodsDCF Analysis InfographicHow discounted cash flow (DCF) really work. This DCF analysis infographic walks through the various steps involved in building a DCF model in Excel.
• Relative valuation methods – using comparable public companiesComparable Company AnalysisHow to perform Comparable Company Analysis. This guide shows you step-by-step how to build comparable company analysis ("Comps"), includes a free template and many examples. Comps is a relative valuation methodology that looks at ratios of similar public companies and uses them to derive the value of another business and precedent transactions
• Break-up valuation methods – looking at the liquidation or break-up value of the business
• Real options valuation methods – rarer
• Here is an overview of all valuation methodsValuation MethodsWhen valuing a company as a going concern there are three main valuation methods used: DCF analysis, comparable companies, and precedent transactions. These methods of valuation are used in investment banking, equity research, private equity, corporate development, mergers & acquisitions, leveraged buyouts and finance

When would you not use a DCF valuation methodology?

You would not use a DCF valuation methodology when a company does not have forecastable cash flowsThe Ultimate Cash Flow Guide (EBITDA, CF, FCF, FCFE, FCFF)This is the ultimate Cash Flow Guide to understand the differences between EBITDA, Cash Flow from Operations (CF), Free Cash Flow (FCF), Unlevered Free Cash Flow or Free Cash Flow to Firm (FCFF). Learn the formula to calculate each and derive them from an income statement, balance sheet or statement of cash flows.  An example of this would be a start-up company. Below is a screenshot of a DCF model from CFI’s online financial modeling courses.

What are the most common multiples used to value a company?

This is one of the most common equity research interview questions.  Here are the main types of valuation multiples:

• EV/EBITDAEV/EBITDAEV/EBITDA is used in valuation to compare the value of similar businesses by evaluating their Enterprise Value (EV) to EBITDA multiple relative to an average. In this guide, we will break down the EV/EBTIDA multiple into its various components, and walk you through how to calculate it step by step
• EV/EBIT
• P/EPrice Earnings RatioThe Price Earnings Ratio (P/E Ratio) is the relationship between a company’s stock price and earnings per share. It gives investors a better sense of the value of a company. The P/E shows the expectations of the market and is the price you must pay per unit of current (or future) earnings
• P/B

Why does Warren Buffett prefer EBIT multiples to EBITDA multiples?

EBITDA excludes depreciation and amortization on the basis that they are “non-cash items.”  However, depreciation and amortization also are a measure of what the company is spending or needs to spend on capital expenditure.  Warren Buffett is credited as having said: “Does management think the tooth fairy pays for capital expenditures?” Here is an article on why Buffett does not like EBITDAWarren Buffett - EBITDAWarren Buffett is well known for disliking EBITDA. Warren Buffett is credited for saying “Does management think the tooth fairy pays for CapEx?".

Compare EBIT vs EBITDAEBIT vs EBITDAEBIT vs EBITDA - two very common metrics used in finance and company valuation. There are important differences, pros/cons to understand. EBIT stands for: Earnings Before Interest and Taxes. EBITDA stands for: Earnings Before Interest, Taxes, Depreciation, and Amortization. Examples, and.

How is valuing a resource company (e.g., oil and gas, a mining company, etc.) different from valuing a standard company?

First, you need to project the prices of commodities and the company’s reserves. Rather than a standard DCF, you use a Net Asset Value (NAV) model. The NAV model is similar, but everything flows from the company’s reserves rather than a simple revenue growth / EBITDA margin projection. You also look at industry-specific multiples such as P / NAV in addition to the standard multiples. Here are more mining valuation methodsMining Asset Valuation TechniquesThe main mining valuation methods in the industry include price to net asset value P/NAV, price to cash flow P/CF, total acquisition cost TAC & EV/Resources. The best way to value a mining asset or company is to build a discounted cash flow (DCF) model that takes into account a mine plan produced in a technical report.

Why do DCF projections typically go out between 5 and 10 years?

The forecast period is driven by the ability to reasonably predict the future.  Less than 5 years is often too short to be useful.  More than 10 years becomes difficult to forecast reliably.

What do you use for the discount rate in a DCF valuation?

If you are forecasting free cash flows to the firm, then you normally use the Weighted Average Cost of Capital (WACCWACCWACC is a firm’s Weighted Average Cost of Capital and represents its blended cost of capital including equity and debt. The WACC formula  is = (E/V x Re) + ((D/V x Rd)  x  (1-T)). This guide will provide an overview of what it is, why its used, how to calculate it, and also provides a downloadable WACC calculator) as the discount rate.  If you are forecasting free cash flows to equity, then you use the cost of equity.

How do you calculate the terminal value in a DCF valuation?

This is one of the classic equity research interview questions.  Terminal valuesTerminal Value​The terminal value is used in valuing a company. The terminal value exists beyond the forecast period and assumes a going concern for the company. either use an exit multiple or the Gordon Growth (terminal growth rateTerminal Growth RateThe terminal growth rate is a constant rate at which a firm’s expected free cash flows are assumed to grow at, indefinitely. This growth rate is used beyond the forecast period in a discounted cash flow (DCF) model, from the end of forecasting period until and assume that the firm’s free cash flow will continue) method.

Explain why we would use the mid-year convention in a DCF valuation?

With standard DCF, there is an assumption that all cash flows occur at the end of the year.  The mid-year convention adjusts for this distortion by making the assumption that all cash flows come mid-way through the year.  Instead of using discount periods of 1 for the first year, 2 for the second year, etc., in the DCF formula, we use 0.5 for the first year, 1.5 for the second year, and so on. For training on financial modeling click here.

More interview questions

We hope this has been a helpful guide to equity research interview questions and answers!  If you want more practice, take a look at our other interview guides and interactive career mapMapInteractive Career Map - discover your career path in corporate finance. Learn which job is right for you: salary, personality, skills, certifications etc. to advance your finance career:

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