Documenting Valuation Assumptions Clearly

A valuation model is a story told in numbers. Without clear documentation of your assumptions, that story becomes fiction you cannot defend. CFA Institute Standard V(A) requires members to understand model assumptions and limitations, test model output, and select approaches appropriate for available data. Even if you are not a CFA charterholder, these principles separate defensible analysis from speculation.

Why this matters: When your thesis is challenged (and it will be), documented assumptions let you explain exactly why you made each choice. Undocumented assumptions become liabilities.

The CFA Standard V(A) Requirements (What You Must Do)

CFA Standard V(A) on Diligence and Reasonable Basis establishes clear requirements:

1. Understand the parameters used in your model (not just plug in defaults)
2. Understand the assumptions and limitations inherent in any model
3. Test model output before incorporating it into analysis
4. Select an approach appropriate for available data quality
5. Ensure purpose and perspective consistency (valuing for acquisition versus minority stake)

The durable lesson: Model choice and input derivation require skill and judgment. Documentation proves you exercised that judgment.

What Happens When You Skip Documentation

Consider this scenario: You valued a technology company at $85 per share using a DCF. Six months later, the stock trades at $60, and your client (or your manager) asks why you recommended buying. Without documentation, you cannot reconstruct your thinking. Did you assume 20% revenue growth or 15%? Was your WACC 9% or 11%? You do not remember, and the spreadsheet just shows a number.

With documentation, you can say: "I assumed 18% revenue growth based on management's Q2 guidance and 3-year historical average of 16%. I used 10% WACC based on Damodaran's industry beta of 1.15 and January 2025 equity risk premium of 4.33%. The stock declined because growth came in at 8%, below both my assumption and consensus."

The point is: Documentation transforms an unexplainable loss into a learning opportunity. You can identify which assumption failed and update your process.

The Seven Elements to Document (For Every Key Input)

For each material assumption in your model, document these elements:

1. Source

Where did this number come from?

• Management guidance (cite the earnings call or investor presentation)
• Historical data (specify the period: "5-year average 2019-2023")
• Third-party research (analyst name, firm, date)
• Damodaran data (specific dataset and date retrieved)
• Your own calculation (show the formula and inputs)

2. Rationale

Why is this assumption appropriate for this company?

Not: "Industry average beta is 1.2."

Instead: "Company has lower financial leverage than industry average (debt/equity of 0.3 vs. industry 0.6), suggesting beta should be below industry average. I used 1.05 based on Bloomberg adjusted beta for the company itself."

3. Sensitivity Range

What is the reasonable high and low bound for this assumption?

Why this matters: If you cannot define a plausible range, you do not understand the assumption well enough to use it.

4. Key Drivers

What would cause this assumption to change?

• Revenue growth: "Dependent on new product launch in Q3; regulatory approval pending"
• Margins: "Dependent on input cost stability; commodity prices volatile"
• Discount rate: "Sensitive to Fed policy; if rates rise 100bp, WACC increases ~50bp"

5. Model Limitations

What does this model not capture?

• DCF does not capture optionality (R&D pipelines, land banks)
• Trading comps do not capture control premium
• Precedent transactions include synergies specific to acquirer

6. Alternative Approaches Considered

Why did you choose this method over others?

"Used DCF rather than DDM because company does not pay dividends and has negative free cash flow in near term. Used perpetuity growth method for terminal value because stable-state business with GDP-like growth is appropriate assumption for mature phase."

7. Update Triggers

What events would invalidate these assumptions?

• Quarterly earnings miss by more than 10%
• Management guidance revision
• Competitor announcement affecting market share assumptions
• Macro event (recession, rate change) outside scenario range

Practical Documentation Template

Use this format for each valuation:

VALUATION DOCUMENTATION
Company: [Name]
Date: [YYYY-MM-DD]
Analyst: [Your Name]

MODEL SELECTION
Method: [DCF / DDM / Trading Comps / etc.]
Rationale: [Why this method fits this company]
Limitations: [What this method cannot capture]

KEY ASSUMPTIONS

1. Revenue Growth
   - Base case: [X%]
   - Source: [Management guidance / Historical / Third-party]
   - Rationale: [Why appropriate]
   - Range: [Low] to [High]
   - Update trigger: [What would change this]

2. Operating Margin
   - Base case: [X%]
   - Source: [...]
   - Rationale: [...]
   - Range: [...]
   - Update trigger: [...]

3. WACC Components
   - Risk-free rate: [X%] (Source: 10-year Treasury as of [date])
   - Equity risk premium: [X%] (Source: Damodaran implied ERP January 2025)
   - Beta: [X] (Source: Bloomberg 2-year weekly, adjusted)
   - Cost of debt: [X%] (Source: Company's BBB-rated bond yield)
   - Tax rate: [X%] (Source: Effective rate from 10-K)
   - Capital structure: [D/E ratio] (Source: Market values as of [date])

4. Terminal Value
   - Method: [Perpetuity growth / Exit multiple]
   - Perpetuity rate: [X%] (Should not exceed long-term GDP growth)
   - OR Exit multiple: [Xx] (Source: Current peer median)
   - Rationale: [Why appropriate for stable state]

VALUATION OUTPUT
- Base case: $[X] per share
- Bear case: $[X] per share
- Bull case: $[X] per share
- Current price: $[X] per share
- Implied upside/downside: [X%]

CROSS-CHECKS
- Trading comps implied value: $[X]
- Precedent transactions implied value: $[X]
- Reverse DCF implied growth: [X%] (vs. your assumption of [X%])

INVESTMENT CONCLUSION
[Buy / Hold / Sell] based on [reasoning]
Key risks to thesis: [List 2-3]
Monitoring triggers: [What would change your view]

Common Documentation Failures (And How to Avoid Them)

Failure 1: Using Default Assumptions

Bad: "WACC of 10% is standard for technology companies."

Good: "WACC of 9.8% derived from: risk-free rate of 4.5% (10-year Treasury as of December 2024), equity risk premium of 4.33% (Damodaran January 2025 implied), beta of 1.15 (company-specific 2-year weekly regression), cost of debt of 5.5% (YTM on company's 2028 bonds), marginal tax rate of 25%, target D/E of 0.25 (management stated goal)."

Failure 2: Undocumented Growth Assumptions

Bad: "Revenue growth of 15% in years 1-5."

Good: "Revenue growth of 15% in Year 1 (consistent with management's Q3 2024 guidance of '14-16%'), declining linearly to 8% by Year 5 (converging to industry growth rate per IBISWorld forecast), then 3% perpetuity growth (slightly above long-term US GDP of 2-2.5% reflecting pricing power in oligopoly market structure)."

Failure 3: No Sensitivity Analysis

Bad: "Intrinsic value is $87 per share."

Good: "Base case value is $87 per share. A 1% increase in WACC reduces value by approximately 10-12% to $77-78. If growth comes in 3 percentage points below forecast, value falls to approximately $70. The stock is attractive only if you believe growth will meet or exceed 12% (my base case is 15%)."

The point is: Point estimates create false precision. Ranges create honest uncertainty.

The Accountability Framework

Documentation creates accountability in three dimensions:

To yourself: When you revisit a position 6-12 months later, you can evaluate which assumptions proved correct and which failed. This is how you improve as an analyst.

To stakeholders: Whether clients, managers, or investment committees, you can explain exactly why you reached your conclusion. "I was wrong because X" is more valuable than "I don't remember."

To regulators: CFA Institute and FINRA require reasonable basis for recommendations. Documentation is your evidence of diligence.

The durable lesson: The quality of your documentation reflects the quality of your thinking. If you cannot explain an assumption in writing, you do not understand it well enough to use it.

Next Step

Take your most recent valuation model. For each of the three most sensitive assumptions (typically growth, discount rate, and terminal value), write one paragraph documenting the source, rationale, and range. If you cannot write that paragraph, you have found a weakness in your analysis. Fix it before making investment decisions based on that model.