What is important in analysis to try to estimate?

Profit development one year ahead is crucial for share price

If you could estimate the results of companies one year ahead with an accuracy of about +/- 10%, then you could in many cases make a lot of money.

If you look at the shares that have appreciated 30-100% or even more last year, you will most likely find one common characteristic with them all: their sales and/or especially EBIT or EPS growth has been much bigger than investors had expected last year. In many cases, with smaller companies there were clear signs of that kind of potential to be seen, but nobody brought these things forward to wide audience. Perhaps this is because nobody really followed those small companies carefully enough. These kinds of opportunities are the ones that the analyst should try plot. And of course it is also important to find opposite cases with unexpected bad performance.

Difference to consensus is also crucial - compare you estimates with consensus

The markets price each stock according to its own expectations. The best estimate of market’s expectations is provided by the consensus estimates. Thus, if there are consensus estimates available, you should always compare your estimates to them and have clear reasons why your estimates are higher or lower than consensus. These are the most important things that you should also write to your forum comments. If you e.g. expect that the company profit (EBIT, PTP, EPS) for next quarter is clearly bigger than the consensus seems to believe - and that is not a non-recurring phenomenon but more permanent rise of performance level - then this should also mean a share price increase directly after the result announcement. Therefore you should tell this in your forum-comments and also give good reasons why you expect better performance than research providers in consensus.

In Valuatum Platform there usually are consensus estimates available for analysts, so finding consensus should not be a problem. Of course we can not have consensus for every small company as there probably isn't consensus available. Partly this is also because we do not have access to figures of every consensus provider. However, the consensus that we have in Valuatum Platform available for analysts is going to significantly increase already in the near future so majority of the companies followed should also include some consensus estimates.

Even though profit development next year is very important to estimate roughly in the right range, it does not make much sense to try to put much energy to estimates that are more than 2 years in the future. They should of course be rational, consistent and at certain generally defined reasonable level as explained later on in own chapter, but to be honest they have very little intrinsic value. Of course they affect the DCF-based fair value, but it is not a parameter that really determines the share price as explained better below. The real pricing of the stock is normally done at the markets by the pricing multiples of current year and next year. So profit development about 2 years from this moment is most crucial, often even shorter periods. Other future years are the less meaningful the further in the future they are. Estimating about distant future is very difficult and market does not even try to do it honestly in determining the right share price level. The market does discount also the distant future and thus the market value of profitable growth companies often includes assumptions of good performance in many future years. In the same way the market value of unprofitable companies often includes assumptions of continuing bad performance in future years. This is however different thing as it is done in a very general way. What really determines current share price is the performance here and now and the performance in near future where markets have clear visibility.


Company performance in this quarter

As stated above the share price of a company is determined with performance in near future where markets have clear visibility. With industries in dynamic or cyclical environment the markets normally have good visibility only for current quarter results that is published in few weeks time as from that "future" they have both management guidance and lots of news flow from what has happened. It means that in most cases there is no tremendous share price effect with the next result announcement, and thus there is also no tremendous value available even though you could estimate the next quarter result with two-digit-accuracy two weeks before it is published. This can be best seen from share price graphs: a good result announcement might increase the share price by a couple of percentage points within the announcement day, but in this kind of cases the share price has normally appreciated during the past quarter normally by more than 10%-points.

So, only a fraction of the upside potential is realised with the result announcement and most of it is already in the share price. It also means that you should concentrate not on "the decimals of this quarter result" but preferably on "the trend and expected rough level of profits in current quarter and couple of quarters thereafter". In other words the investors are not so interested if you can say a week before the result that the result will be in rage 234.9 - 235.1, as they would be if you can credibly explain why the result of the company will be on average increasing about 20% e.g. in the next three quarters. The first one is most likely already in the share price, but the latter is hardly there.

Some people might hereby protest and see it particularly important that the analyst is able to accurately forecast the result a week before the result announcement. Admittedly thereby investors might be able to earn some percentage points as I already stated above. And also these kinds of short-term predictions are much more valuable and interesting than comments right after the result about what did happen and why the result was like it was - without any new information to markets about what will happen next quarters.

To sum up: market expectations are conservative and wait status quo to remain

At this point you perhaps feel a bit confused about what is important in the analysis: Is current quarter important or not? And what is it that markets expect currently and what does it not expect?

This is how we believe the market normally behaves and what it expects:

    *   Well performing companies - Markets are conservative: if the sales and profits of a company have been increased by e.g. 30% a year for already some time then market expects that the situation will stabilize and the growth will slow down soon. If you are sure that the growth will continue or even accelerate during the next year, then it is most likely a buy-case: the share price will probably appreciate during that year much more than the normal cost of equity i.e. more than about 10%. On the other hand, if positive development breaks very rapidly (as markets normally expect gradual slowdown) then the share price might come down also very quickly.
    *   Ordinary and stable companies - Markets expect the status quo to continue. If you have reasons to believe that this kind of company suddenly improves (or declines) a lot then there is big upside (downside).
    *   Poor companies - Markets normally expect the companies to get out of trouble very slowly. And markets normally do not believe until they see clear facts about the improvement (first positive quarter). So promises of improvement are normally not fully discounted into the share price. These cases offer always upside if you have reasons to believe to the improvement. If there is no improvement, then this kind of companies are of course always overpriced: loss-making companies are options where investors bet on improvement. If the improvement does not come then anything is too much to pay for these companies.

Note! Each standard case above must be used and viewed in the light of current valuation: if the pricing ratios like P/E are very high then of course market expects very good profit development in the future years. If P/E ratio or P/BV ratio is extraordinary low then the markets expect already quite bad performance to continue for some time. This means e.g. that "ordinary and stable" company might for some reason (very optimistic management guidance, rumours etc.) have great expectations (high pricing ratios) inside its current valuation and thereby of course continuing stable performance is a disappointment for markets and decreases share price. You can use e.g. valuation scatter to compare valuation ratios vs growth /profitability estimates of different companies.

What period is then important for the analyst to forecast?

Above is discussed what markets normally expect from different companies. You should focus on the periods which are as close as possible (to be interesting) but so far away that the markets do not (yet) see there. So if you feel that markets do not know about next quarter, then you should focus on that. If the question is about a big company and the next quarter result announcement is quite close, then it is often the case that markets do already know a lot and there is very little room for surprises.

Thus "what markets do not see" depends slightly on situation and thus varies case by case. Naturally you do not have to try to dig something "surprising" for every company as there are perhaps no unexpected things going to happen during the next year - at least things that could be foreseen. That kind of cases should normally be in "Hold" => if there is nothing that the markets would already know by now, everything is already discounted in the current share price. Then there is no reason for you to say that the share should be "BUY" or "SELL". Of course there is one exception: if a company is very profitable and perhaps even grows fast, then it is of course a BUY if it "only" can maintain its status quo as markets can never price this kind of companies with their intrinsic value but rather wait - very rationally - that the performance will deteriorate sooner or later.

And remember also that forecasting in itself means nothing, only your arguments within these forecasts mean something.