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How Accurate Are Stock Market Predictions?

Analysts must use a stock forecast for revenue and growth to determine what the expected earnings are expected to be. The forecasted growth and revenue projections are important components of security analysis. They often contribute to a stock’s potential worth. For instance, if the company has shown a strong rate of growth over a number of time periods, it is likely to command multiples that exceed the current market price. If its forward multiple rises and its price rises, it will consequently increase, resulting in higher returns to investors. For forward projections, there are many inputs; some come from quantitative data while others can be more subjective. The accuracy and reliability of the data is the main factor that determines the forecasts.

Forecasting Revenue

Growth and revenue forecasts are most reliable when the inputs used to determine the forecast are as exact as is possible. To forecast revenue, analysts collect data from companies, the industry, and consumers. Typically, both companies and industry trade groups publish information on the likely volume of the market the amount of competitors, as well as current market shares. These data are available in annual reports and through industry groups. Data on consumer behavior gathered from buyer questionnaires UPC bar-coding and other outlets provide an impression of the present and anticipated demand.

Further inputs are needed to specifically model a company’s revenue projections. Financial statements, such as those in the balance sheets inform analysts of the inventory of the company’s present and changes in inventory levels from one year to the next. Sometimes, companies provide information on the status of their inventory, shipment and the anticipated number of unit sales in the current time.

Average price per unit can be determined by taking the amount of revenue reported in the income statement and divided by the inventory change (or the amount of units sold). For past transactions, these data can found in the US organization’s Securities and Exchange Commission (SEC) reports. However, regarding future transactions assumptions are required, like the impact of competition on price power and expected demand versus supply.

In competitive markets the prices tend to fall whether directly as a result of price reductions, or indirectly in the form of rebates. The competition can be seen in the form of similar products offered by different manufacturers, or with new products entering and cannibalizing old ones. When the demand for a product is higher than the supply, companies usually push products to the consumer which usually results in lower price points. The forecasted revenues are calculated by taking the average selling price (ASP) for future periods and multiplying it by the expected number of units sold. Forecasts calculated using this method can be “confirmed” by management of the company, who may discuss revenue and their expectations for growth during conference calls that are typically held around the time of the release of the latest annual or quarterly report. In addition, the management of the company could be involved in events within the same period, such as industry conferences in which they announce new data on inventory levels, market competitiveness, or pricing in order to verify or aid in creating revenue models.

Forecasting Growth

Once the revenue has been determined then future growth can be calculated. By calculating a rate of growth on revenues can help determine future earnings growth. Determining the proper rate of growth will be determined by the expectation of the product’s pricing and unit sales to come. Persistent penetration into existing and new markets and the ability to capture market share could affect the future sales of units. Market outlook, understanding the most important product features, as well as demand are crucial to forecasting growth rates.

Impact of Forecasts on Valuation

The ultimate goal of analysts in forecasting growth and revenues should be to establish the best price for a share. After calculating expected revenue and concluding that the costs will continue to be the same fixed proportion of revenue analysts are able to calculate projected earnings for each period.

From these models, analysts can now look at the ratio of earnings growth to revenue growth to see how well the business can control costs and boost revenue growth towards the top line.

The variation in growth rates will reflect in the valuation ratio the market will pay for the stock. Stocks that have steady or growing growth rates will be awarded higher multiples. Those with negative growth will get lower multiples. For ABC the growth rate from year 1 to 2. This will result in a higher multiple, while decrease in growth of Years 4 (actually negative growth in earnings when compared to revenue growth) will be shown in a lower multiple.
The Bottom Line

Forecasts of analysts are essential in determining the expected price of stocks which, in turn, will result in recommendations. Without the ability to make accurate forecasts, the determination to purchase or sell a share cannot be taken. Though stock forecasts require compilation of many qualitative data points from many sources as well as subjective assessments analysts ought to be able create an adequate model to make recommendations.