How do you align sensitivity analysis with your strategic objectives and valuation purpose in DCF?

Valuation purpose varies based on long, short, or accumulate positions. For long positions, it aims to assess intrinsic value for potential gains. Sensitivity analysis can align with strategic objectives by evaluating scenarios impacting asset value. For short positions, valuation seeks overvaluation and short-term profits. Sensitivity analysis focuses on factors that could trigger value decline. For accumulate positions, valuation purpose is to build a portfolio gradually while managing risks. Sensitivity analysis helps analyze key variables to align with overall investment goals. Overall, aligning sensitivity analysis with strategic objectives helps optimize portfolio performance and long-term investment success.

As a financial professional, I am passionate about empowering informed decision-making; Aligning purpose with sensitivity analysis fosters exceptional results. Your purpose (acquisition, investment, divestment) guides your DCF approach, scope (detailed for acquisitions, streamlined for divestments), and granularity (intricate modeling for investments, readily available data for divestments). Aligning sensitivity analysis with purpose unlocks a deeper understanding of how critical variables impact valuation. This empowers you to make informed strategic decisions to enhance model credibility and communicate results with clarity.

For long positions, factors like revenue growth, market demand, and competitive landscape drive valuation. In short positions, factors such as regulatory changes, negative news, and financial performance impact valuation. Accumulate positions consider factors like diversification benefits, macroeconomic conditions, and investment horizon. Sensitivity analysis can evaluate how these drivers affect the strategies and align it with overall goals on top of adjusting Growth, Risk (WACC) & Cash flows.

Key drivers - variables impacting cash flow and valuation - can be internal (revenue growth) or external (market share), financial (EBITDA) or non-financial (brand reputation). The most relevant drivers depends on industry. Within tech startups, for example, customer acquisition cost (CAC) directly affects FCF. In manufacturing, raw material prices might be more critical to include as a key driver. Ideal drivers for sensitivity analysis are threefold: 1. Cash Flow Relevance: Impacting projected cash flows (e.g. TGR) 2. Future Value Uncertainty, highlighting the need for exploration through sensitivity analysis. 3. Controllability (e.g. an acquirer influencing the target's CapEx plans.) There are more drivers that can be selected.

In bear markets, long positions focus on identifying undervalued assets, while short positions seek profits from price declines. Sensitivity analysis assesses impacts of market downturns. On the brighter side, bull markets, long positions target assets with growth potential, while short positions manage risks during market exuberance. Sensitivity analysis helps align strategies with market conditions. In addition to this, base case scenarios evaluate asset performance in current market conditions, optimizing long-term gains and short-term opportunities.

Ranges should be realistic, based on historical data, industry benchmarks, or expert opinions. For example, a tech startup's CAC could be $100-$200 based on industry data. To take it further, one can use best-case, base-case, and worst-case scenarios for each driver, allowing us to explore a range of potential outcomes. Coming back to the tech startup example, a best-case could be $80, base-case $150, and worst-case $220. But what about interdependencies? A lower CAC might lead to higher marketing spend, impacting another driver. Sensitivity analysis can account for these correlations in order to establish a more holistic picture of the model.