Scenario and Sensitivity Analysis
No one knows exactly how fast a company will grow. Scenario and sensitivity analysis replace one confident guess with a range of honest possibilities.
Why this matters for beginners
A single precise valuation feels reassuring but hides how much depends on uncertain assumptions. Learning objectives: build base, bull and bear scenarios, read a sensitivity table, and avoid false precision.
Main explanation
A scenario is a coherent story about the future. A base case reflects what seems most likely, a bull case where things go well, and a bear case where they go poorly.
The key assumptions are usually revenue growth, profit margins and the valuation multiple the market might pay later. Small changes in each can move the result a lot.
The discount rate turns future cash into today's value. A higher rate lowers the value of distant cash, which hits long-duration growth companies hardest.
A sensitivity table changes one or two assumptions at a time. Example: with 5 percent growth and a 15x multiple a share might be worth 60; with 10 percent growth and 20x it might be worth 95; with 2 percent growth and 12x only 40.
False precision means writing 73.42 when your inputs are rough guesses. A range like 50 to 90 is more honest and more useful.
The aim is not to find the right number but to learn which assumptions matter most, then focus research on those.
Example using a real company
For a cyclical company like Deere, a bear case with lower farm income and a bull case with strong replacement demand can produce very different results from the same business.
- →Bear: 2 percent growth, 12x multiple, value about 40.
- →Base: 5 percent growth, 15x multiple, value about 60.
- →Bull: 10 percent growth, 20x multiple, value about 95.
Common beginner mistakes
- ✕Trusting a single precise number.
- ✕Making the bull case realistic and the bear case gentle.
- ✕Changing many assumptions at once so you cannot see which one matters.
Key terms
- Scenario analysis
- Valuing a company under several coherent stories about the future.
- Sensitivity table
- A grid showing how value changes as one or two assumptions change.
- Discount rate
- The rate used to convert future cash into today's value.
- False precision
- Presenting an estimate as more exact than its inputs allow.
Key takeaways
- 01Think in ranges, not single numbers.
- 02Find the assumptions that move value most.
- 03A fair bear case matters as much as a bull case.
Check yourself
- 01What is the main purpose of a sensitivity table?
- 02Which is more honest when inputs are rough guesses?
- 03How does a higher discount rate affect valuation?
- 04What does a bear case describe?
- 05Why change only one or two assumptions at a time?
Try the concept on a real company
Open a company in the Analyzer and write down a bear, base and bull assumption for its growth.
Educational examples only. Not buy or sell recommendations.