Forward Earnings
What are Forward Earnings?
Forward earnings are an estimate of the next period's earnings of a company, usually till the completion of the current fiscal year and sometimes to the accompanying fiscal year. Forward earnings are modeled by analysts, often with guidance from management, that will project near-term revenues, margins, tax rates, and other financial data for investors and investment analysts.
Understanding Forward Earnings
Forward earnings are of interest to investors because stock prices are supposed to reflect future earnings prospects discounted to the present. Historical earnings (last period or trailing twelve months) provide different amounts of data depending on the nature of the firm and industry, the position in the business cycle, and the state of the economy, that can help determine forward earnings numbers.
For example, a large consumer staples company that recently experienced 4% earnings per share (EPS) growth in a global economy that grew 3% would lend itself to relatively accurate forward earnings estimates. A mid-cap technology company providing cloud infrastructure services in a fast-changing industry does not lend itself to consistently reliable forward earnings estimates.
Determining Forward Earnings
In the event that a company's management provides earnings guidance, it is used as a starting point for an analyst to model a forward EPS. It is assumed that management is in the best position to assess its future prospects. Generally speaking, management gives guidance for the current fiscal year and updates that guidance every quarter or when a material change in its evaluation forces it to update investors intra-quarter.
Sometimes, management will provide a longer-term view of its reasonable expectations for sales growth, margins, free cash flow growth, etc. Analysts who cover the companies will then model the financials, applying their own assumptions and perhaps tweaking management guidance (e.g., incrementally higher or lower operating margins), to produce forward valuation metrics such as forward price-to-earnings (P/E), forward price-to-sales (P/S), or forward enterprise value-to-EBITDA (EV/EBITDA).
These valuation metrics can be useful to investors as long as they are aware about the odds of precision with respect to the type of company subject to analysis.
Argument Against Forward Earnings
Numerous investors believe that choosing an investment based on forward earnings is not the most prudent method, particularly when compared to using historical earnings. The rationale for this is that anticipating the future is troublesome.
Analysts can utilize data they believe will be correct, however can still not predict interest rates, stock market performance, or any legislation or regulatory changes. Furthermore, as they don't have total insight into a company, they can not predict company earnings, as they might not have all the data to do so correctly. Research shows, that on average, forward earnings are 10% higher than realized earnings, it are overly optimistic to mean that analysts.
It is because of these reasons that critics of forward earnings believe that relying on it as an investment indicator can destroy value and therefore they rely on historical earnings as a better gauge to where a company will be in the next year.
Highlights
- Investors are interested in forward earnings because a company's stock price is intended to reflect the future earnings prospects.
- Forward earnings project future revenues, margins, tax rates, and other financial data.
- There are critics of forward earnings, who believe it's anything but a prudent tool to rely on when making investments as it is challenging for analysts to correctly predict future metrics.
- Forward earnings are an estimate of a company's earnings for upcoming periods, usually the completion of the current fiscal year and often the accompanying fiscal year.
- Analysts model data with guidance from management to arrive at forward earnings.
- Historical data, such as previous earnings history, nature of the industry, and the health of the economy, provide essential input into forecasting forward earnings.
