Financial modeling is a key component of stock valuation, and essential to stock valuation is forecasting a company's growth and revenues to estimate its expected earnings over specific periods.

Estimated earnings are then used to estimate growth, which helps🔯 analysts value a stock, decide whether it is over- or undervalued, estimate profit potential, and assign it a multiple—factors critic🀅al to stock selection.

Forecasting Revenue

Analysts begin forecasting revenue by gathering financial data from a company, its industry,💫 consumer behaviors, and economic and competitive conditions. Any publicized company events, such as the pending release of a new product or a merger or acquisition, are factored into the analysis.

Typically, both companies and industry trade groups publish data related to the potential size of the market, the number of competitors, and current market shares. This information can be found in annual reports and through industry group💮s. Consumer data ascertained from buyer surveys, UPC bar coding, and similar outlets paint a picture of current and future expected demand. 

Further inputs are needed to specifically model a company’s revenue forecasts. Financial statements, such as the 澳洲幸运5官方开奖结果体彩网:balance sheet, inform analysts of a company’s assets 🦂and debts and any changes from one period to another. Often, companies provide updates on inventory, shipments, and expected unit sales in the current period.

Pricing Data

Average price-per-unit can be calculated using the revenue provided in the income statement divided by the change in inventory (or number of units sold). For past transactions, these data can be found in 澳洲幸运5官方开奖结果体彩网:Securities and Exchange Commission (SEC) reports, but for future transactions, assumptions are required—like t🌸he impact of c൲ompetition on pricing power and expected demand versus supply.

In competitive markets, prices usually fall, either directly through price cuts or indirectly in the form of rebates. Competition comes in the form of similar product𒆙s by different manufacturers, or new products entering and cannibalizing old ones. When supply exceeds demand, companies usually push products to the consumer, typically resulting in lower price points.

Calculating Forecast Revenue

Forecasted revenue is usually calculated by multiplying the 澳洲幸运5官方开奖结果体彩网:average selling price (ASP) for future periods by the number of expected units sold. These calculated forecasts can be “confirmed” by company management, who may discuss revenue and its expectations for growth on conference calls, usually scheduled around the release of the latest annual or quarterly report. Additionally, company management may participate in intra-period events, such as industry c♔onferences, where they release new information on inventory, market competitiven🎶ess, or pricing to confirm or assist in building revenue models.

Forecasting Growth

Once revenue is determined, future growth can be modeled. Applying a 澳洲幸运5官方开奖结果体彩网:growth rate on revenue can help determine the future earnings growth. Setting the appropriate⛦ growth rateღ will be based on expectations about product price and future unit sales. Penetration into new and existing markets and the ability to steal market share will impact future unit sales. Industry outlook, analyzing the key product features, and demand are integral components to forecasting growth rates.

Let’s look at an example. Assume company ABC starts with $100 in revenue. It is expected to grow in-line with the ma🍬rket. ABC is forecasting its ability to increase market share and set prices. Here is its𒁏 forecast:

Growth Rate Calculation

The following table estimatesꦆ the growth rate using:

• Market growth: An estimate of the market's growth rate
• Incremental market share gains: An estimate of the increases in market share over a period
• Pricing power: An estimate of a company's ability to raise prices without decreasing demand

In Ye🐽ars 3 and 4, both incremental market share and pricing power decrease, which directly impacts growt🤡h rates. 

Impact of Forecasts on Valuation

Analysts’ ultimate goal when forecasting revenue and growth is to determine the appropriate value for a stock. After modeling expected revenue and concluding that co💞sts will be close to the same fixed percentage ♍of revenues, analysts can calculate expected earnings for each future period.

The following table shꦅows 🔜the expected earnings for Company ABC:

From these models, analysts can then compare earnings growth to revenue growth to see how well the comp💃any is able to manage costs and bring revenue growth to the bottom line. 

In Years 1, 2, and 3, ABC’s expected earnings growth exceeds its revenue growth. The change in growth rates will be reflected in the valuation multiple the market is willing to pay for this stock. Stocks with sus🍷tainable or increasing growth rates will be assigned higher multiples, and stocks with no or negative growth will receiv💛e lower multiples. For ABC, increased growth from Year 1 to Year 2 will result in a high multiple, while the low growth in Year 5 (actually negative earnings growth compared to revenue growth) will be reflected in a lower multiple.

The Bottom Line

Analysts’ forecasts are crucial to setting expected stock prices, which, in turn, lead to recommendations. Without the ability to make accurate forecasts, the determination to buy or sell a stock cannot be made. Although stock forecasts require the compilation of many quantitative data points from a variety of sources, as well as subjective determinations, analysts should be able to create a fa🅺irly accurate model to make recommendations.