ACCT820 Chapter 10 Forecasting Financial Statements[1]

ACCT820 Chapter 10 Forecasting Financial Statements[1] -...

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Introduction to Forecasting Analysts must develop realistic expectations for the outcomes of future business activities; to develop these expectations, analysts build a set of financial statement forecasts – expected o Financial statement forecasts represent an integrated portrayal of a firm’s operating, These activities determine the firm’s future profitability, growth, financial o Financial statement forecasts are important tools b/c the analyst can derive expectations of future payoffs to equity shareholders – earnings, CFs, & dividends – which are the fundamental bases for share value Financial statement forecasts also are important tools in many other decision contexts o Credit decisions require expectations for future CFs available to make required o Managers’ decisions about firm strategy, potential customer or supplier relationships, potential M&As, & potential carve-outs of divisions or subs, & even whether a firm presents a good employment opportunity, all depend on their expectations for future Developing forecasts of future payoffs is in many ways the most difficult step of the 6 step framework b/c it requires the analyst to estimate the effects of future activities, which involves a high degree of uncertainty; further, forecast errors can prove very costly o Optimistic forecasts can lead the analyst to overstate future earnings & CFs or underestimate risk & therefore make poor investment decisions based on an overstated value of the firm o Pessimistic or conservative forecasts can lead the analyst to understate future earnings o Analysts need to develop realistic (unbiased & objective) expectations of future o Empirical research results from Nichols & Wahlen suggest the potential to earn abnormal returns by correctly forecasting the sign of the change in annual earnings numbers o Their findings indicate that if a person had accurately predicted the sign of the change in earnings 1 year ahead for each firm in their sample during their 14 year period, he would have earned returns that beat the market by roughly 19% per year by investing in those firms that experienced earnings increases & by roughly 16% per year by selling short those firms that experienced earnings decreases The evidence in Nichols & Wahlen also suggests that investors have the potential to earn even greater abnormal returns by correctly forecasting the sign & magnitude of the change in 1 year ahead earnings o Their findings imply that stock returns for the firms that experience the largest %
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ACCT820 Chapter 10 Forecasting Financial Statements[1] -...

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