There is a lot to consider when it comes to forecasting, and that's why financial analysts spend a significant time determining what data sets are most impactful in their forecasts. Financial analysts often look at stock prices, economic indicators such as GDP growth rates, the unemployment rate, and consumer sentiment index before making predictions about future events. They also compare current conditions against past trends for clues about where things might head next.
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Forecasting is an art and science.
Taking accurate measurements and inputting this data in a forecasting model is crucial to producing an accurate forecast. It, however, does not always provide correct estimates because they can sometimes be too broad or too narrow. The input data can also be inaccurate or outdated, which can alter the entire forecast.
There are three standard views of what makes a forecast:
1) A forecast is a statement made at the time "T" about an event that will occur at a time "T+n."
2) A forecast is a statement about the value of a variable in the future.
3) A forecast is just one possible outcome, given the information currently available.
Typically, Financial Analysts use forecasts as part of their valuation process to help assess what values are reasonable for key variables used in their analysis.
Factors to consider while generating forecast:
1) What is Forecasting?
Typically, forecasts are about revenue, earnings per share (EPS), future dividends, or cash flows.
2) How Frequently is the Forecast being Made?
Most forecasts utilize regularly. One example would be financial analysts who use quarterly sales estimates for each firm within their coverage universe to make buy/sell recommendations to their clients.
3) Who makes the forecast?
The individual who generates the forecast can (and should) affect its reliability. A seasoned financial analyst will often generate more reliable estimates than a novice analyst.
4) Is there a Methodology Used to arrive at the forecast?
There should always be a rational methodology behind any forecast used in valuation:
- A correlation between two variables
- The expected future growth in a variable (i.e., revenue or EPS)
- A regression analysis of historical data that plots the predictor against the predicted
5) How are Data Being Collected?
Many analysts use forecasts based upon past performance, which can be unreliable if used for an extended period. An example would be new management instituting changes that reduce costs or increase revenues, improving future cash flows.
6) What is the Liquidity of the Asset?
It would be best if you considered the liquidity of an asset:
- How easy is it to sell at market value?
- Are there restrictions on its sale?
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