MSG Team's other articles

9322 The Financial Benefits of Warehouse Automation

Retail organizations across the world face multiple challenges when it comes to managing their business operations. Managing retail warehouses is one such challenge. The task of effectively managing a warehouse can be quite complicated. This is because of the fact that retail warehouses typically contain several thousand SKUs. These SKUs can be stored in pallets […]

10589 Pension Funds and the Use of Derivatives

Pension funds across the world are meant to be low-risk financial instruments. They are allowed to take slightly more risks in some parts of the world as compared to others. However, for the most part, pension fund across the world is advised to stay away from risky instruments such as derivatives. Derivatives have been known […]

9605 How Does The Failure of Silicon Valley Bank Affect Stakeholders

The fall of the Silicon Valley Bank happened very suddenly. The bank had gone from a healthy functioning bank to near bankruptcy within 48 hours! As a result, the credibility of the entire American banking system has been brought into question. This is because commercial banks are not like regular organizations. In most cases, they […]

8891 Demystifying the Mysterious, Glamorous, and Demanding World of Investment Banking

The Lure of Investment Banking and Why is it so for Management Practitioners All aspiring management students as well as career professionals’ dream of working in either a management consultancy or an investment bank during their education and working life. Indeed, asks any MBA (Masters of Business Administration) student about their dream jobs, chances are […]

10883 Quick Ratio – Meaning, Formula and Assumptions

The quick ratio is a variation of the current ratio. However, a quick ratio is considered by many to be a more conservative estimate than the current ratio. This characteristic fetches it the nickname of being the “Acid test ratio”. The difference between the current ratio and the quick ratio is the fact that quick […]

Search with tags

  • No tags available.

In the past few articles, we have studied about the various models that are available to help us predict the value of a firm based on the dividends that it provides. However, all these models had one flaw. They expected that the dividends of the firm will follow some set pattern. For instance, the assumptions were that that the dividend of a firm will continue to rise for 5% for the next 3 years.

Now, the reasons behind these assumptions were twofold. Firstly, dividends are difficult to predict. Hence, assuming a pattern reduces the risk of making mistakes. Thus, the ease of forecasting is one of the reasons. Also, calculations related to valuation of stocks have to be conducted at a fast pace. Hence, the formulas assume simplistic patterns in which dividends are expected to behave in the future. This is for calculation ease.

However, both the forecasting ease and the calculation ease make the formula less effective and less accurate. Therefore, in real life, analysts almost always use more complex tool like spreadsheet models to come up with a more accurate valuation.

Real Life Scenarios Are Complex:

Real life scenarios are much more complex. Almost no company is able to follow a predictable pattern when it comes to making dividend payments. Companies may experience a 5% growth this year but may soon experience a 3% decline the next year. Multiple factors like macro-economy, the nature of competition, the changing purchasing powers etc determine the stability of the dividends. For most companies, these factors will not be stable and hence their dividends are unlikely to match the trends which are built in any of the formulas.

Valuation Is Sensitive To Inputs:

Some degree of error is always present in all calculations. If the error is small then the effort required to correct it may not be worth the while. However, valuation models are extremely sensitive to changes in inputs. This is because they are calculating values of cash flows over a very long period of time. Hence, the inputs need to be perfect and errors cannot be ignored. Thus analysts simply cannot work with the suboptimal results that the formula provides and a better mechanism is required.

Infinite Possibilities Can Be Built In:

This is where spreadsheet modeling comes to the rescue. Spreadsheet tools have advanced calculation capabilities. They can process millions of bits of data and provide the relevant answer in a few seconds. Also, spreadsheet modeling allows separating the inputs from the calculations. Thus, scenario analysis can be conducted with extreme ease and in a matter of minutes.

Scenario Analysis:

Scenario analyses have become more and more important in the recent past. Analysts and investors have realized that it is almost impossible to predict the exact movement in the valuation of a company. Hence, instead of looking for one value, they are usually looking at a range of values. These ranges provide a more accurate estimate of what the future is expected to be like. It is here that scenario analysis helps a lot. Analysts can vary the inputs in different combinations and note down the effect of the change in these inputs in the valuation of the firm.

Sensitivity Analysis:

While conducting the scenario analysis, analysts can also understand the relationship between individual inputs and the valuation derived. In some cases, growth rate may be the most important factor whereas in other cases the discount rate may be of more importance. Either ways, spreadsheet models help uncover these relationships in real time with almost no effort.

In conclusion, it needs to be understood that there is really nothing that cannot be done manually which the spreadsheet models do for us. Spreadsheet models just help us to automate the whole process and increase the speed at which these calculations can be conducted. But, in the financial markets, speed is what is of utmost importance and hence spreadsheets have become an integral part of the business.

Any analyst who wishes to have a fruitful career in finance ought to be aware of and skilled in the use of spreadsheets to create financial models.

Article Written by

MSG Team

An insightful writer passionate about sharing expertise, trends, and tips, dedicated to inspiring and informing readers through engaging and thoughtful content.

Leave a reply

Your email address will not be published. Required fields are marked *

Related Articles

Calculating Free Cash Flows: The Case of Preferred Shares

MSG Team

Calculating Free Cash Flow to Equity

MSG Team