Calculating and Interpreting Results
Now that the valuation model is complete, we are ready to put it to work. Start by testing the validity of the model. Even a carefully planned model can have mechanical errors or errors in economic logic. To help you avoid this, we present a set of systematic checks and other tricks of the trade that test the robustness of the model. During this verification, also ensure that key ratios 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 prioritize strategic actions.
Next, to deepen the understanding offered by your valuation, use scenario analysis. Start by determining the key uncertainties that affect the company’s future, and use these uncertainties to construct multiple forecasts. Uncertainty can be as simple as whether a particular product launch will be successful, or as complex as 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 analysis will not only guide ...