Volatility

All forecasts are wrong.

.. the challenge for an investor is in estimating by how much and by which way.

VOLATILITY, which is a measure of the range of potential outcomes, is therefore an inherent part of any investment decision. For WACC based equity valuations, this can be used as a proxy for RISK, albeit a pejorative term and concept, in order to apply an additional discount.  This however, fails to recognise that volatility cuts both ways and can also offer an opportunity value, something recognised in many derivatives instruments and related valuation models such as Black Scholes.

The key point here is that Volatility is neither good nor bad, it just is and needs to be recognised as such. There are times when one may wish less volatility and times when one wants more, such as when you have an above average level of confidence in which way the forecasting risk may be skewed. Understanding the margin of error on potential outcomes and how this might drop-thru to a valuation is therefore an essential part of managing volatility in a portfolio, both risk and opportunity. If you don't know, you can't choose.

Empowered?

At the GrowthRater we strive to empower users with the insight, data and tools to make better investment decisions. This includes full transparency around a structured valuation methodology where one can track margin of error on organic sales growth through our proprietary company models and interactive tools and data sets. A 10 year trailing analysis is used as a default period for calculating margins of error and marginal revenue drop-thru rates, but all these can be redefined by users in the various sensitivity and valuation modules. Flex an organic sales growth or margin assumption and see real-time the impact on the valuation, both graphically presented and with full data support tracking the impact down through to operating FCF, balance sheet adjustments and GrowthRating revision.

In the below table, is the margin of error data by company for Organic Sales Growth, GrowthRating and prospective Valuation. While the first two series are based on our default period (a trailing 10 year), it should be noted that the Valuation margin of error is a forward looking prospective measure as it applies these historic ranges (including marginal revenue drop-thru rates) against our prospective company forecasts, including capital structure. 

Margin of Error table