Marwaan Karame

than precisely wrong.” Our Monte Carlo simulation provides a range of 1,000 scenarios to determine the probability associated with making a minimum return of 20%, as well as the probability of taking a loss through either a short or long position. For each scenario, a random value is generated for the unknown inputs in our discounted Economic Value model. These random values are based on reasonable ranges derived from 10 year historical distributions of company and peer data. While point estimates are often “precisely wrong”, range estimates provide a more realistic view of market variability and have a greater chance of the actual outcome falling within the estimated range. Additionally, we scrutinize the inputs of our Monte Carlo simulation through our Economic Value (also known as Economic Profit, Economic Value Added, or EVA) calculation, where adjustments are made to accounting statements to more accurately reflect the economics of each driver. As a result, our historical distributions are often a reliable source for predicting the range of values for key drivers, where levels of confidence can be quantified and investors have the necessary information to weigh their individual risk tolerance against the tradeoff between uncertainty and return. Beyond the financial drivers for the Monte Carlo simulation, Economic Value also provides us with insights into strategy and compensation, two important factors that impact the long-term outlook of a company’s performance. Economic Value helps to link finance to strategy by quantifying two strategic value drivers, the market economics of the industry and the company’s competitive position. The strategic value drivers adds another dimension to our analysis in determining the company’s ability to capture and sustain an increasing share of the industry’s Economic Value. However, if management compensation is not aligned with shareholder interests, it is often a matter of time before strategies and performance reflect the incentives of management at the expense of shareholders. Therefore we compare management incentives against their track record for creating shareholder value to determine how strongly management and shareholder self interests are aligned. In summary, the application of Economic Value and Monte Carlo simulation produces superior insight for evaluating uncertainty compared to point estimates and offers a very powerful and elegant valuation methodology.