basisforarguingthatanalystpredictionsofgrowthratesmust
bebetterthanpredictionsusingmodelbasedontimeseriesor
other historical data simply because they use more
information. The evidence indicates, however, that this
superiorityinforecastingissurprisinglysmallforlong-term
forecastsandthatpastgrowthratesplayasignificantrolein
determining analyst forecasts.
Thereisonefinalconsideration.Analystsgenerallyforecast
earningspershare,andmostservicesreporttheseestimates.
Whenvaluingafirm,youneedforecastsofoperatingincome,
andthegrowthinearningspersharewillnotbeequaltothe
growthin operating income.In general,thegrowth ratein
operating income should be lower thanthe growthrate in
earningspershare.Thus,evenifyoudecideto useanalyst
forecasts,youwillhaveto adjustthemdowntoreflectthe
need to forecast operating income growth.
Analyst forecasts may be useful in coming up with a
predicted growth ratefor a firm,but there is a dangerin
blindlyfollowingconsensusforecasts.Analysts oftenmake
significanterrorsinforecastingearnings,partlybecausethey
dependon thesame datasources (which might havebeen
erroneousormisleading)andpartlybecausetheysometimes
overlooksignificantshiftsinthefundamentalcharacteristics
ofthefirm.Thesecretto successfulvaluationoftenliesin
discovering inconsistencies between analysts’ forecasts of
growthandafirm’sfundamentals.Thenextsectionexamines
this relationship in more detail.
Fundamental Growth