Scenario analysis replaces a single price target with a range of outcomes – a bull, base and bear case – each assigned a probability. Multiplying each outcome by its probability and adding them up gives an expected value: one number that respects the full range of what could happen, rather than pretending the future is certain.
This guide shows how to build the three cases, assign and justify probabilities, fold them into an expected value, and avoid the error that quietly breaks most scenario work: internal inconsistency.
Why one number isn’t enough
A single price target hides how uncertain the future really is. Scenario analysis makes that uncertainty explicit by modelling three distinct futures: a bull case where things go well, a base case that is most likely, and a bear case where they go badly. Seeing the spread between them tells you as much as the central figure – a narrow spread signals confidence, a wide one signals risk.
The expected value formula
The three cases are combined into one figure using probability.
Setting probabilities
The probabilities are where judgement enters, and they follow two firm rules: they must sum to 100%, and each must be explicitly justified rather than plucked from the air. The base case, being the most likely, carries the highest weight. A worked example, illustratively:
| Scenario | Target | Probability | Contribution |
|---|---|---|---|
| Bull | £60 | 25% | £15.00 |
| Base | £45 | 55% | £24.75 |
| Bear | £30 | 20% | £6.00 |
| Expected value | £45.75 | ||
The probabilities sum to 100%, and the expected value of £45.75 sits close to the base case but is pulled a little by the upside and downside. Against a current price of, say, £40, that frames a modest expected gain with a defined downside.
Internal consistency – the most common error
The single biggest mistake in scenario analysis is mixing variables from different stories. Every variable in a scenario must follow from the same narrative. A bull case cannot pair record revenue growth with a recession-level margin; a bear case cannot assume a demand collapse alongside premium pricing. If the inputs within one case contradict each other, the output is meaningless however neat the maths looks.
Catalysts and timing
Strong scenario analysis ties each case to specific catalysts – the events that would push the company toward that outcome, and roughly when. A bull case might hinge on a product launch landing or a margin target being hit by a given quarter; a bear case on a contract loss or a regulatory ruling. Mapping scenarios to catalysts turns an abstract range into something you can actually watch unfold.
Reading scenario analysis critically
When you encounter scenario work in a note, a few checks reveal its quality:
- Do the probabilities sum to 100%? If not, the expected value is simply wrong.
- Is the bull case a single coherent story, or a stack of every possible good thing happening at once?
- Is the bear case realistic? A bear target that still sits above today’s price means no genuine downside has been modelled – a red flag.
- Are the probabilities justified, or asserted? Weights with no reasoning behind them are guesses dressed as analysis.
Key takeaways
- Scenario analysis models a bull, base and bear case instead of a single target.
- Expected value = the sum of each outcome multiplied by its probability.
- Probabilities must sum to 100%, be justified, and give the base case the highest weight.
- Internal consistency is essential – every variable in a case must follow one narrative.
- Tie each scenario to specific catalysts and a rough timeframe.
- A bear case above today’s price means no real downside has been modelled.
Frequently asked questions
What is scenario analysis?
Scenario analysis models several possible futures for a stock – typically a bull, base and bear case – each with a probability, then combines them into a single expected value. It makes the uncertainty in a forecast explicit rather than hiding it behind one target.
How do you calculate expected value?
Expected value is the sum of each scenario’s outcome multiplied by its probability. For example, a £60 bull at 25%, a £45 base at 55% and a £30 bear at 20% give 15 + 24.75 + 6 = £45.75. The probabilities must sum to 100%.
How should probabilities be set in scenario analysis?
They must sum to 100% and each should be explicitly justified rather than guessed. The base case, as the most likely outcome, carries the highest weight, with the bull and bear cases weighted to reflect their realistic likelihood.
What is the most common mistake in scenario analysis?
Internal inconsistency – mixing variables that belong to different narratives within one case, such as a bull case combining record growth with recession-level margins. Every input in a scenario must follow from the same coherent story.
What makes a scenario analysis a red flag?
Probabilities that do not sum to 100%, a bull case that stacks every good outcome at once, unjustified weightings, or a bear-case target that still sits above the current price – which means no genuine downside has been modelled.
Sources and further reading
For professional standards on analysis and forecasting, see the CFA Institute. All companies, figures and probabilities in this article are illustrative.
Build a full bull/base/bear framework, set and weight probabilities, and watch the expected value update live.
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