Lesson 6 of 6 · 15 min
Scenario analysis: risk factors, cost structure and sensitivity
Instead of a single point forecast, the analyst builds scenarios around the key risk factors, carries each through revenue and a fixed/variable cost structure to EPS, and tests how sensitive the result is to the most uncertain assumptions.
In short
- Four generic risk factors affect all companies to different degrees: business cycle, competition, inflation/deflation and technological developments.
- Build several scenarios (e.g. bull, base, bear), judge their likelihood, and compare them with other analysts' forecasts and with what the current valuation implies.
- Technology can shift supply right (lower costs) or demand left (attractive substitutes). In a highly competitive industry, cost savings are usually passed on through lower prices.
- Estimate the fixed/variable split: %Δ(total costs) ÷ %Δrevenue ≈ variable share; or assign a fixed % to each cost line and weight them.
- High fixed costs mean operating leverage: lost revenue cuts operating income and margins more than proportionally. A sensitivity table shows results across a grid of assumptions.
Unlock this lesson free for 7 days
Create a free account to get 7 days of full access — every lesson, video, flashcard, mock and the question bank. No card needed.