Series 86 — Research Analyst Qualification Examination (Part I) Quick Review

Quick Review: How to Use This Page

This independent quick review is for candidates preparing for FINRA’s Series 86 — Research Analyst Qualification Examination (Part I), exam code Series 86. It is designed for fast review before you move into topic drills, mock exams, and detailed explanations.

Use it in three passes:

1. Concept pass: confirm you know what each valuation, accounting, and quantitative tool is used for.
2. Trap pass: focus on sign errors, numerator/denominator mismatches, timing errors, and accounting adjustments.
3. Practice pass: use independent companion practice with original practice questions, a question bank, topic drills, and detailed explanations to convert recognition into exam-speed application.

This page is independent review support. FINRA’s current materials and instructions control the actual exam experience.

High-Yield Series 86 Skill Map

Series 86 Part I rewards candidates who can connect company data, market data, accounting choices, valuation methods, and economic context.

Core Valuation Workflow

    flowchart TD
	    A[Understand business and industry] --> B[Normalize historical financials]
	    B --> C[Forecast operating drivers]
	    C --> D[Estimate free cash flow]
	    D --> E[Choose discount rate]
	    E --> F[Calculate explicit-period value]
	    F --> G[Estimate terminal value]
	    G --> H[Derive enterprise value]
	    H --> I[Adjust to equity value]
	    I --> J[Divide by diluted shares]
	    J --> K[Compare to market price and risks]

The highest-yield valuation mistake is not the math itself; it is mixing valuation frameworks. For example, using FCFF but discounting at the cost of equity, or using an equity multiple with an enterprise value numerator.

Financial Statement Analysis Essentials

Three-Statement Review

Accrual vs. Cash Review

Working Capital Sign Rules

For cash flow from operations using the indirect method:

Candidate trap: “current asset up” usually uses cash; “current liability up” usually provides cash.

Ratio Dashboard

Profitability Ratios

Liquidity, Leverage, and Coverage

Efficiency Ratios

DuPont Analysis

DuPont breaks ROE into operating performance, asset efficiency, and leverage.

\[ \text{ROE} = \frac{\text{Net Income}}{\text{Revenue}} \times \frac{\text{Revenue}}{\text{Average Assets}} \times \frac{\text{Average Assets}}{\text{Average Equity}} \]

Interpretation:

• ROE rises because margin improves: potentially higher pricing power or cost control.
• ROE rises because asset turnover improves: more efficient use of assets.
• ROE rises because leverage increases: higher risk; not necessarily better operating performance.
• ROE falls despite higher net income: equity base or asset base may have grown faster than earnings.

Free Cash Flow Review

FCFF vs. FCFE

FCFF formula:

\[ \text{FCFF} = \text{EBIT}(1 - T) + \text{D\&A} - \text{Capex} - \Delta \text{NWC} \]

FCFE formula:

\[ \text{FCFE} = \text{CFO} - \text{Capex} + \text{Net Borrowing} \]

High-yield cash flow traps:

• Depreciation is added back because it reduced accounting earnings but did not use current-period cash.
• Capex is subtracted because it is a cash investment, even though it may not immediately hit the income statement.
• An increase in net working capital is subtracted because it ties up cash.
• Interest treatment matters: FCFF is before payments to debt holders; FCFE is after debt-related effects.
• EBITDA is not free cash flow: it ignores capex, taxes, working capital, and often cash interest.

Earnings Quality Checklist

Forecasting and Modeling Decision Rules

Revenue Forecasting

Cost and Margin Forecasting

Balance Sheet Forecasting

DCF Valuation: Exam-Speed Framework

DCF Steps

1. Normalize historical financials.
2. Forecast revenue, margins, taxes, working capital, and capex.
3. Calculate FCFF or FCFE consistently.
4. Select the correct discount rate.
5. Discount explicit forecast-period cash flows.
6. Estimate terminal value.
7. Convert enterprise value to equity value if using FCFF.
8. Divide by diluted shares.
9. Compare implied value to current market price.
10. Stress-test key assumptions.

Terminal Value

Gordon growth terminal value:

\[ \text{Terminal Value}_n = \frac{\text{FCF}_{n+1}}{r - g} \]

Key traps:

• \(g\) must be less than \(r\).
• Use next-period cash flow, not current-period cash flow.
• Terminal value is calculated at the end of the explicit forecast period, then discounted back.
• Terminal value often drives a large portion of DCF value; small changes in \(g\) or \(r\) can have large effects.

Enterprise Value to Equity Value

\[ \text{Equity Value} = \text{Enterprise Value} - \text{Debt} - \text{Preferred Stock} - \text{Minority Interest} + \text{Cash and Nonoperating Assets} \]

Then:

\[ \text{Equity Value per Share} = \frac{\text{Equity Value}}{\text{Diluted Shares Outstanding}} \]

Common candidate mistake: stopping at enterprise value when the question asks for equity value per share.

Discount Rates and Required Return

CAPM

\[ r_e = R_f + \beta(\text{Market Risk Premium}) \]

Interpretation:

• Risk-free rate: should match currency and horizon of cash flows.
• Beta: measures sensitivity to market returns, not total business risk.
• Market risk premium: compensation for bearing equity market risk.
• Higher beta: higher required return and lower present value, all else equal.

WACC

\[ \text{WACC} = \frac{E}{D+E}r_e + \frac{D}{D+E}r_d(1-T) \]

Decision rules:

Beta Adjustments

When comparing firms with different leverage, analysts may unlever and relever beta.

Trap: higher debt generally increases equity risk, which can increase levered beta and cost of equity.

Relative Valuation Multiples

Common Multiples

Numerator/Denominator Matching

High-yield rule: cash flows available to all capital providers pair with enterprise value; cash flows available only to common shareholders pair with equity value.

Interpreting Multiple Differences

A higher multiple may be justified by:

• Higher expected growth
• Higher margins
• Better return on invested capital
• Lower business risk
• More predictable cash flow
• Stronger competitive position
• Lower capital intensity
• Better corporate governance or management execution

A lower multiple may reflect:

• Cyclicality
• High leverage
• Declining margins
• Customer concentration
• Regulatory or litigation risk
• Weak cash conversion
• Poor earnings quality

Dividend Discount Models

The Gordon growth model:

\[ P_0 = \frac{D_1}{r-g} \]

Use it when dividends are stable, meaningful, and tied to long-term earnings capacity.

Sustainable growth concept:

Sum-of-the-Parts and Asset-Based Valuation

Trap: do not apply one peer multiple to a conglomerate if segments have very different growth, margins, and risk.

EPS, Dilution, and Capital Structure

Basic EPS:

\[ \text{Basic EPS} = \frac{\text{Net Income} - \text{Preferred Dividends}}{\text{Weighted Average Common Shares}} \]

Diluted EPS includes potentially dilutive securities when they reduce EPS.

Capital structure effects:

Economics and Industry Analysis

Macro Variables

Business Cycle Review

Industry Structure

Porter-style competitive forces are useful for research analysis:

Sector-Specific Valuation Cues

Do not memorize sector metrics mechanically. Ask: What economic driver creates value in this business?

Quantitative and Statistical Review

Time Value and Capital Budgeting

NPV:

\[ \text{NPV} = \sum_{t=1}^{n}\frac{CF_t}{(1+r)^t} - C_0 \]

IRR is the discount rate that makes NPV equal zero.

Risk and Return

Regression Interpretation

Arithmetic vs. Geometric Return

Trap: if the question asks for compounded performance, geometric return is usually more relevant than arithmetic average.

Accounting and Valuation Traps Candidates Miss

Inventory

Trap: inventory method affects margins, taxes, working capital, and comparability.

Depreciation

Trap: accelerated depreciation lowers early accounting income but may not change total cash economics except through taxes.

Leases and Debt-Like Obligations

For analysis, long-term contractual obligations can behave like debt. Watch for:

• Leverage that is not obvious from simple debt balances
• Fixed payments that affect coverage
• Comparability issues between companies with different lease intensity

Goodwill and Impairment

Trap: a noncash impairment does not directly reduce current cash flow, but it may reveal that prior investment assumptions were too optimistic.

Analyst Judgment: What the Question Is Really Testing

Formula Quick Sheet

Fast Decision Tables

Which Valuation Method?

Which Discount Rate?

What Raises Valuation?

Common Wrong-Answer Patterns

Mini Review: Reading a Research Problem Stem

When a Series 86 question gives a company scenario, read in this order:

1. Company type: bank, industrial, technology, retailer, commodity producer, REIT, utility, etc.
2. Metric requested: EPS, FCFF, enterprise value, equity value, ROE, WACC, multiple, NPV.
3. Time period: trailing, current, forward, terminal, annualized, quarterly.
4. Basis: pre-tax vs. after-tax, nominal vs. real, book vs. market, basic vs. diluted.
5. Capital claim: enterprise-wide or common equity only.
6. Adjustment clues: excess cash, debt, preferred, minority interest, one-time charges, working capital.
7. Question wording: “increase,” “decrease,” “most likely,” “least likely,” or “all else equal.”

Practice Plan for Final Review

Use this Quick Review as a checklist, then move into independent companion practice.

A strong final review sequence:

1. Rework missed questions without looking at explanations.
2. Write the rule that would have prevented each error.
3. Redo the same topic drill after a short delay.
4. Mix topics so you must choose the method, not just apply a known formula.
5. Use mock exams to test pacing and endurance.
6. Review detailed explanations for both correct and incorrect choices.

Final Readiness Checklist

Before sitting for the real FINRA Series 86 — Research Analyst Qualification Examination (Part I), confirm you can:

• Calculate and interpret major profitability, liquidity, leverage, efficiency, and valuation ratios.
• Move confidently between income statement, balance sheet, and cash flow effects.
• Compute FCFF and FCFE and select the correct discount rate.
• Build the bridge from enterprise value to equity value per share.
• Identify when to use P/E, EV/EBITDA, EV/Sales, P/B, DCF, DDM, or sum-of-the-parts.
• Explain why a multiple is higher or lower than peers.
• Interpret business cycle, interest rate, inflation, currency, and industry effects.
• Understand beta, correlation, regression output, NPV, and IRR at exam speed.
• Spot common traps in timing, tax treatment, dilution, cash flow classification, and numerator/denominator matching.

Next step: use original practice questions in a Series 86 question bank, work targeted topic drills, and study the detailed explanations until you can explain both the right answer and the most tempting wrong answer.