Accuracy is not the illusion in BV, says Pellegrino, precision is

BVWireIssue #124-4
January 23, 2013

The recent item on the "Illusion of Accuracy" may have resurrected a frequent discussion among BV professionals—whether a rounded number in a value conclusion is perceived as more accurate than a nonrounded number—but Mike Pellegrino (Pellegrino & Associates) would like to take it to a new level.

“First, no appraiser can guarantee accuracy,” he says, “even in an ex-post analysis,” which contains “embedded conditional probabilities” that are beyond anyone’s abilities to predict (particularly with Excel). Further, the hypothetical precondition of the fair market value standard virtually “guarantees that a valuation conclusion will never be accurate, unless by accident or coincidence.” In fact, the only thing an appraiser can guarantee is precision. “Consider shooting at a target. Hitting the bull's eye once out of 100 shots shows an accuracy of 1%, but no precision. Hitting a single number 99 times out of 100 shows remarkable precision (99%), but no accuracy.”

Even an “illusion of precision” is easy to audit, Pellegrino says. “Is the math correct? What is the confidence interval on the value conclusion after running through 10,000 simulations of the valuation model? Did the analyst account for uncertainties in all material value drivers, and if so, how?” A competent valuation analyst can answer those questions authoritatively.

For what it is worth, Pellegrino has had “remarkable debates with fellow practitioners and attorneys on the topic of rounding.” He’s also done extensive research, ultimately failing to find any deals that didn’t close because they depended on nonrounded numbers or court cases that were lost based on unrounded value conclusions. At the same time, “how many judges have excluded BV appraisers for using rules of thumb and other undocumented, unproven theories in litigation?” Pellegrino asks. Perhaps that is the discussion that BV appraisers should continue having.

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