3 Simple Ways To Stock Forecasting
April 03, 2021
If you want to become wealthy through being a successful investor, you will need to buy great companies — preferably at reasonable prices. In the last blog post we learned about stock valuation and how to find the fair value of a stock.
From that post you remember that we had to input our estimated growth for the stock into Rikas.ai in order to get the intrinsic value.
But how do you predict the growth of a stock?
In this blog post we will learn three approaches to predict the future growth — leading to better investment decisions and more 💰.
In the examples we will use earnings per share (EPS) as our metric for measuring the growth of a company, you could substitute it for a similar metric such as net income, or even derive the growth from several metrics as we do at Rikas.ai.
Let’s get started!
1. Analysts
Financial analysts study financial data and use their findings to help companies make business decisions — the information can also be published to our use. It is good to keep in mind that someone is paying for the analysis to be published and it can therefore be biased. However, with enough data points (analyst forecasts) we can get a good grasp on what kind of growth can be predicted for a stock.
If you are using analyst predictions we highly suggest to go for the more conservative side of the range due to the above mentioned phenomenon.
Let’s check out some forecasts:
Here we have 43 analysts that have forecasted Apple’s EPS to be between 3.74 and 5.5 USD in 2022, with a consensus at 4.69.
The 2020 reported EPS for Apple was 3.28 EPS.
Now if we want to predict the year on year (YOY) growth rate we first need to take the predicted value, remember we generally want to be on the safe side, so we’d like to choose something between the bottom of the range and the consensus — let’s choose 4.0 for simplicity.
Then we need to divide the estimate with the latest reported earnings to get the total growth:
Finally we need to take nth root of the value to get the yearly growth rate. N is the amount of years in the future the estimated value is for, so in our case 2:
There you go, we have estimated the future growth for Apple to be 10%.
Let’s plug it into Rikas and see what would be the fair value for Apple with the given growth estimate.
With our growth estimate Apple stock seems overpriced today.
You may want to choose a more optimistic estimate if you are very familiar and confident in the stock.
2. Past Growth
The second approach to estimating the growth of a stock is by looking at the historical growth of the company. As the saying goes, past performance is not a guarantee of future success, but a consistent growth in the past can be quite a good estimate for future growth.
We can find the past earnings from 2017 forward from the same graph:
Following the calculations from the last section we can then derive that Apple has grown EPS about 9% YOY in the last 4 years.
If possible you would like use the past 10 years for this analysis whilst also looking at the consistency in the growth.
When using past performance as a predictor it is important to see if the derived value can be justified for the future — for example high growth stocks are likely to grow less in the future than they have in the past.
3. Combination of approaches
The third approach is combining the two approaches, as we mentioned in the last blog post on stock valuation determining the value and estimating growth is a combination of art and science — therefore, the more aspects you cover — the better.
Bonus
The general trend of the industry can effect the estimate either positively or negatively — industry growth can be found from this list published by the NYU.
Originally published at https://rikas.ai.
