Valuation, 7th Edition

17Analyzing the Results

Now that the valuation model is complete, we are ready to put it to work. Start by testing its validity. Even a carefully planned model can have mechanical errors or flaws in economic logic. To help you avoid such troubles, this chapter presents a set of systematic checks and other tricks of the trade that test the model’s sturdiness. During this verification, you should also ensure that key ratios like return on invested capital are consistent with the economics of the industry.

Once you are comfortable that the model works, learn the ins and outs of your valuation by changing each forecast input one at a time. Examine how each part of your model changes, and determine which inputs have the largest effect on the company’s valuation and which have little or no impact. Since forecast inputs are likely to change in concert, build a sensitivity analysis that tests multiple changes at a time. Use this analysis to set priorities for strategic actions.

Next, use scenario analysis to deepen the understanding that your valuation provides. Start by determining the key uncertainties that affect the company’s future and use these to construct multiple forecasts. Uncertainty can take the form of a simple question (will a product launch be successful?) or a complex one (which technology will dominate the market?). Construct a comprehensive forecast consistent with each scenario, and weight the resulting equity valuations by their probability of occurring. Scenario ...