Predicting the Future Earnings of a Company
The value of a stock is driven by the assets the company currently owns and, more importantly, the future earnings of the company. For this reason, accurately projecting future earnings, and discounting those earnings appropriately to today’s dollars, is critical in arriving at the true or “intrinsic” value of a stock.
Looking at Past Earnings to Project Future Earnings
While there are various methods for attempting to predict the future earnings of a company, the greatest indicator may be in its past. A company that has demonstrated only modest growth for, say, the past decade is unlikely to accelerate that growth in the future. Stock investors are encouraged to keep this in mind as they conduct their valuations and guard against undue optimism.
Earnings Guidance
Earnings guidance or “forward-looking statements” refer to a company’s management comments about how well it expects that company to perform in the future. This guidance is offered so that investors can evaluate the company’s earnings potential and make investment decisions regarding that company. Often, management will offer hints regarding the earnings prospects over the next quarter or fiscal year to try to create investor consensus as to what is achievable. In offering this information, management must be sure to provide it to all shareholders and not just a select group of analysts.
Earnings Guidance Calendar
Evaluating Earnings in Stages
In conducting earnings-based valuations, investors with often divide company growth into stages. First-stage or “near-term’ growth is typically the next ten years and second-stage growth is the timeframe beyond that. Investors will often assign a higher growth rate to the first-stage and the near-term may be seen as more certain and predictable. Second-stage earnings are harder to predict accurately and therefore incorporate higher risk. To arrive at an intrinsic value under this approach, a growth rate and discount rate are assigned to each of the two stages and the discounted streams are summed.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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