question archive 1) Many students of financial statement analysis, like new analysts, produce overly optimistic forecasts for a firm
1) Many students of financial statement analysis, like new analysts, produce overly optimistic forecasts for a firm
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1) Many students of financial statement analysis, like new analysts, produce overly optimistic forecasts for a firm. Some managers are also optimistic in their forecasts. What would you see as evidence of such over-optimism in their forecasts, and what possible explanations are there for such behavior?
2) Ali Baba, an analyst with Smart Beta Inc., claims: ‘It is not worth my time to develop detailed forecasts of sales growth, profit margins, etcetera, to make earnings projections. I can be almost as accurate, at virtually no cost, using the random walk model to forecast earnings’. What is the random walk model? Do you agree or disagree with Ali Baba’s forecast strategy? Why or why not?
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Answer:
1.
To make sure such over-optimism forecasts is accurate, we need to know the Company’s strategy/reason behind it. In example, if the Company forecast that there is significant increase in sales, then we should know what the Company’s marketing strategy is to support the forecasts. Such event happen might be triggered from the superior, with intention to boost the Company’s sales (to inspire marketing team to achieve the higher sales).
2.
Random walk model is one that predicts next year’s earnings will be equal to last year’s earnings. I do not agree with Ali Baba’s forecast strategy, because the best way to forecast future performance is to do it comprehensively A comprehensive approach is useful, and indeed highly recommended, even if the analyst is primarily interested in a single facet of performance, because it guards against unrealistic implicit assumptions.
