Scenario Analysis: Bull, Base, and Bear Cases
Learn to build multiple scenarios that capture the range of possible outcomes, probability-weight them, and make investment decisions under uncertainty.
Learning Objectives
- Construct meaningful bull, base, and bear case scenarios
- Avoid common scenario-building mistakes
- Probability-weight scenarios to create expected values
- Use scenarios to inform position sizing and risk management
Scenario Analysis: Bull, Base, and Bear Cases#
Single-point estimates are comfortable but dangerous. When you say "the stock is worth $75," you're implying false precision. Reality offers a range of outcomes—some favorable, some disastrous.
Scenario analysis acknowledges uncertainty by modeling multiple possible futures.
The Goal: Not to predict the future (impossible), but to understand the range of outcomes and make decisions that work across multiple scenarios.
The Three-Scenario Framework#
Defining Each Scenario#
| Scenario | Definition | Probability Range |
|---|---|---|
| Bull Case | Things go better than expected | 15-30% |
| Base Case | Most likely outcome given current trends | 40-60% |
| Bear Case | Things go worse than expected | 15-30% |
What Differentiates Scenarios#
| Driver | Bear | Base | Bull |
|---|---|---|---|
| Revenue growth | Below guidance | At guidance | Above guidance |
| Margin trend | Contract | Stable/slight expansion | Strong expansion |
| Competitive dynamics | Share loss | Stable | Share gains |
| Macro environment | Recession | Normal | Strong economy |
| Execution | Missteps | On track | Exceeds |
Building Scenarios: A Step-by-Step Process#
Step 1: Identify Key Value Drivers#
For each company, 3-5 factors drive most of the value:
Example: E-Commerce Company
| Driver | Impact on Value | Uncertainty Level |
|---|---|---|
| Revenue growth | Very High | High |
| Take rate/margins | High | Medium |
| Customer acquisition cost | Medium | Medium |
| Competition intensity | Medium | High |
| Macro (consumer spending) | Medium | Medium |
Step 2: Define Scenario Assumptions#
Revenue Growth:
| Scenario | Assumption | Rationale |
|---|---|---|
| Bear | 10% CAGR | Market saturation, competition |
| Base | 18% CAGR | Current trajectory continues |
| Bull | 25% CAGR | New markets, share gains |
Operating Margin:
| Scenario | 5-Year Terminal | Rationale |
|---|---|---|
| Bear | 8% | Competition compresses pricing |
| Base | 12% | Modest operating leverage |
| Bull | 18% | Scale economies, premium pricing |
Step 3: Build Scenario Valuations#
Run your DCF (or multiples analysis) for each scenario:
| Metric | Bear | Base | Bull |
|---|---|---|---|
| 5-Year Revenue CAGR | 10% | 18% | 25% |
| Terminal Operating Margin | 8% | 12% | 18% |
| Terminal Growth | 2% | 3% | 4% |
| Implied Share Value | $45 | $75 | $120 |
Step 4: Assign Probabilities#
Based on your assessment of likelihood:
| Scenario | Value | Probability | Weighted Value |
|---|---|---|---|
| Bear | $45 | 25% | $11.25 |
| Base | $75 | 50% | $37.50 |
| Bull | $120 | 25% | $30.00 |
| Expected Value | 100% | $78.75 |
Probability Assignment
Don't overthink exact probabilities. The value of scenarios isn't precision—it's understanding the range and ensuring you can live with each outcome. 20/60/20 vs. 25/50/25 rarely changes the decision.
Common Scenario-Building Mistakes#
1. Scenarios Too Narrow#
| Problem | Example | Fix |
|---|---|---|
| Bear isn't bearish enough | "Bear case: 12% growth vs. base 15%" | Think about what could truly go wrong |
| Bull isn't bullish enough | "Bull case: 18% growth vs. base 15%" | Consider what would make this a home run |
Good test: If your bear case happens, would you wish you'd never invested? If not, it's not bearish enough.
2. Moving Only One Variable#
Real bear cases involve correlated negatives:
- Revenue misses AND margins compress
- Growth slows AND competition intensifies
- Execution fails AND macro deteriorates
Bad bear case: Revenue grows 10% instead of 15%; everything else unchanged Good bear case: Revenue 10%, margins 5% lower, multiple compression, higher churn
3. Anchoring to Current Price#
Don't reverse-engineer scenarios to justify current valuations:
Wrong approach:
- Stock is at $80
- "Let's assume base case is $80"
- Build scenarios around that
Right approach:
- Build scenarios from business fundamentals
- THEN compare resulting values to current price
- Let the analysis tell you if stock is cheap or expensive
4. Ignoring Probability Shifts#
Probabilities aren't static. New information changes them:
| Event | Probability Shift |
|---|---|
| Positive earnings surprise | Bull probability up |
| Key customer loss | Bear probability up |
| Competitor exits market | Bull probability up |
| Management turnover | Bear probability up |
Update your scenarios as facts change.
Using Scenarios for Decision-Making#
The "Can I Live With It?" Test#
For each scenario, ask:
- Bull: Is the upside worth the risk?
- Base: Am I comfortable with this return?
- Bear: Can I survive this outcome?
If the answer to any is "no," reconsider the investment—regardless of expected value.
Position Sizing Based on Scenarios#
| Situation | Position Size | Logic |
|---|---|---|
| High expected value, wide range | Smaller | Uncertainty warrants caution |
| High expected value, narrow range | Larger | High confidence in upside |
| Modest expected value, protected downside | Standard | Risk/reward balanced |
| Negative expected value | Zero/short | All scenarios point negative |
Entry Point Decisions#
| Current Price vs. Scenarios | Action |
|---|---|
| Below bear case value | Strong buy (very rare) |
| Between bear and base | Attractive entry |
| Near expected value | Fair price, depends on conviction |
| Above base case | Expensive unless high bull confidence |
| Above bull case | Avoid—market is more optimistic than any scenario |
Advanced: Probability-Weighted Return Analysis#
Instead of single expected value, calculate potential returns:
| Scenario | Value | Probability | Return at $70 Price |
|---|---|---|---|
| Bear | $45 | 25% | -36% |
| Base | $75 | 50% | +7% |
| Bull | $120 | 25% | +71% |
| Expected Return | +12% |
But also consider:
- 25% chance of losing 36% (bear risk)
- 75% chance of making money (base + bull)
- Asymmetric payoff: -36% to +71%
Is +12% expected return worth 25% chance of -36% loss? Depends on your risk tolerance and alternatives.
Real-World Example: TechStart Inc.#
Company Profile#
- High-growth SaaS, $200M ARR
- 35% growth, break-even margins
- Entering new market (uncertain)
- Strong competitor also entering
Scenario Definitions#
Bear Case (25%):
- New market entry fails
- Core growth slows to 15%
- Margins stay negative longer
- Value: $1.5B (7.5x ARR)
Base Case (50%):
- Modest new market success
- Core growth 25%
- Break-even by year 3
- Value: $3.0B (15x ARR)
Bull Case (25%):
- New market dominance
- Growth accelerates to 40%
- Profitable by year 2
- Value: $5.0B (25x ARR)
Analysis#
| Metric | Value |
|---|---|
| Expected Value | $3.125B |
| Current Market Cap | $2.8B |
| Upside to Expected | +12% |
| Bear Case Downside | -46% |
| Bull Case Upside | +79% |
Decision: Modestly attractive (+12% expected upside), but 25% chance of -46% is significant. Consider starter position, add on signs of new market success.
Key Takeaways
- Scenario analysis models multiple futures, acknowledging uncertainty
- Build Bull/Base/Bear cases that vary key value drivers (revenue, margins, competitive position)
- Scenarios should be meaningfully different—if bear case materializes, you should regret investing
- Move multiple variables together in correlated ways, not just one at a time
- Don't anchor to current price—let fundamentals drive scenario values
- Probability-weight scenarios for expected value, but also assess return distributions
- Use scenarios for position sizing and entry point decisions
- The "Can I Live With It?" test: ensure you can survive the bear case
- Update probabilities as new information emerges