Sensitivity analysis

Recomputing a valuation with each uncertain input moved across the range you would defend, to see how much the answer depends on each one.

Example

Moving a discount rate between 9% and 11% and perpetual growth between 1.5% and 3.5% produced values from 12,894,000 to 21,143,000.

Important

The table is the output, not a supplement to it. A valuation reported as a single figure has discarded the finding and kept the least informative cell.

Related terms

  • Valuation — An estimate of what an asset is worth, as distinct from the price it currently trades at. Built from what the asset produces plus judgements about growth, duration and required return.
  • Discount rate — The annual rate at which future money is reduced to a present value, reflecting both the time you wait and the risk that the money does not arrive.
  • Terminal growth rate — The rate at which cash flow is assumed to grow forever after the explicit forecast ends. Sits in the denominator of the terminal value formula alongside the discount rate.

Lessons that explain it

  • A projection is tested against the company's own history — Financial projections are most useful when compared with what the company has actually achieved and run through downside scenarios that show when cash would run out. (11 min)
  • The scorecard method starts from what similar deals were priced at — The scorecard method takes the typical pre-money valuation of comparable early-stage deals in a region and adjusts it up or down by comparing the company on weighted factors. (10 min)
  • Several methods give a range; the gaps show what you believe — No single method values an early company reliably. Running several and comparing the results shows the range of defensible prices and exposes which assumptions drive the difference. (10 min)
  • Why valuation is a range, and never a number — Every valuation method takes uncertain inputs and multiplies them together, so the output is a band rather than a figure. The habit worth building is refusing to collapse it. (9 min)
  • Discounted cash flow: the method that shows its assumptions — A discounted cash flow states every assumption out loud, which is its great virtue and the reason it is so easy to abuse. The output moves enormously on inputs that cannot be observed. (14 min)

All 578 terms in the Investing glossary