Valuations are affected by risk, and the world is currently in a heightened state of economic risk as a result of COVID-19. The financial effects can be seen in equity market volatility, with sectors such as oil and gas, construction and retail suffering precipitous falls.
When a market shock ripples through the wider economy in the way COVID-19 has, there’s much to be said about updating the technical elements of valuations such as reforecasting cash flows, recalculating multiples and reassessing risk. However, the current crisis raises broader questions about whether typical valuation practices are fit for purpose, both during the pandemic-induced turmoil and in the longer term once the effects of the pandemic subside.
Valuation practitioners, historically, often consider a ‘base case’ cash-flow forecast as a central estimate for a discounted cash-flow (DCF) valuation. This method assumes implicitly that the upside and downside risks are equal and opposite in terms of both probability and impact, but recent events have led us to question whether this is a reasonable assumption.