Module XVIII·Article III·~3 min read
Sensitivity Analysis
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Sensitivity Analysis
Sensitivity Analysis: managing uncertainty
Sensitivity Analysis (sensitivity analysis) is the systematic study of how changes in key assumptions affect the outcome of the valuation. This is a mandatory element of any investment assessment.
Why is Sensitivity Analysis necessary?
Uncertainty is inherent — all models are based on assumptions
Shows risk drivers — which variables are critical
Supports decision-making — range vs point estimate
Communicates uncertainty — honesty with investors
Key variables for sensitivity
| Variable | Typical range | Impact |
|---|---|---|
| WACC | ±1-2% | Very high |
| Terminal growth (g) | ±1% | Very high |
| Revenue growth | ±5% | High |
| Margin | ±2-3% | High |
| Exit multiple | ±1-2x | High |
| Tax rate | ±5% | Medium |
2D Sensitivity Table (standard)
| Equity Value per Share ($) | WACC 8% | WACC 9% | WACC 10% | WACC 11% |
|---|---|---|---|---|
| g = 1% | $120 | $105 | $92 | $82 |
| g = 2% | $140 | $120 | $105 | $92 |
| g = 3% | $168 | $140 | $120 | $105 |
| g = 4% | $210 | $168 | $140 | $120 |
Current price: $100. Base case: WACC 10%, g = 2% → $105 (+5% upside)
Football Field Chart
Visualization of valuation ranges from different methods:
| Method | Low | Mid | High |
|---|---|---|---|
| DCF | $85 | $105 | $140 |
| Comparable Companies | $90 | $110 | $130 |
| Precedent Transactions | $100 | $120 | $150 |
| 52-Week Range | $75 | $100 | $125 |
Consolidated range: $85-$150, Midpoint: ~$110-115
Scenario Analysis
Combinations of multiple assumptions:
| Scenario | Revenue | Margin | WACC | Value | Probability |
|---|---|---|---|---|---|
| Bull Case | +15% | +3% | 9% | $160 | 20% |
| Base Case | +8% | +1% | 10% | $105 | 50% |
| Bear Case | +2% | -2% | 11% | $65 | 30% |
Probability-Weighted Value $102
Monte Carlo Simulation
For more complex analysis:
- Define distributions for key inputs
- Run 10,000+ simulations
- Obtain distribution of outcomes
- Analyze percentiles (10th, 50th, 90th)
Margin of Safety
Benjamin Graham concept: Buy only with a discount to intrinsic value
| Investor | Margin of Safety | Example |
|---|---|---|
| Conservative | 30-50% | Fair value $100, buy at $50-70 |
| Moderate | 20-30% | Fair value $100, buy at $70-80 |
| Aggressive | 10-20% | Fair value $100, buy at $80-90 |
Communicating Uncertainty
| Bad Practice | Good Practice |
|---|---|
| "Target price: $105" | "Fair value range: $90-120, base case $105" |
| "WACC is 10%" | "WACC 9-11%, sensitivity ±15% on value" |
| "Revenue will grow 10%" | "Revenue growth 5-15%, base case 10%" |
CIO Recommendations
- Always sensitivity tables — never single number
- Focus on key drivers — 2-3 most important variables
- Scenarios for context — tell a story
- Margin of safety — protect against errors
- Update regularly — assumptions change
§ Act · what next