We probably look at 175 – 200 investment opportunities annually (someone actually employs me...). Most of these are brought to us by investment banks, and some come with projections offering a range of outcomes. The best-case projection often looks like a hockey stick: historically flat or with a slight positive trend, but showing explosive growth for the projected period. In stark contrast, the worst-case projection hardly ever shows revenue declining. At worst (according to the materials provided) revenues will remain constant.

We then take this information and develop our own scenarios to appropriately stress test various capital structures under a variety of conditions. In this process I occasionally think back to this entertaining quote from Howard Marks:

We hear a lot about “worst-case” projections, but they often turn out not to be negative enough. I tell my father’s story of the gambler who lost regularly. One day he heard about a race with only one horse in it, so he bet the rent money. Halfway around the track, the horse jumped over the fence and ran away. Invariably things can get worse than people expect. Maybe “worst-case” means “the worst we’ve seen in the past.” But that doesn’t mean things can’t be worse in the future. In 2007, many people’s worst-case assumptions were exceeded.

About Howard Marks: