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"Forecasting is simply a projection of how current imbalances will ultimately resolve."

- Alan Greenspan
In his book "The Age of Turbulence"

Introduction

Earnings (EPS) Projections for the next two or three years is a common and useful tool for analysts. EPS projections act as a valuation anchor to form opinion about over/under pricing. Analysts compare price-earnings multiples (P/E) with peers in the industry using EPS projections. The two most important financial statements which are a bible to the analysts are Income Statement and Balance Sheet. This article tries to explain the mechanics of EPS projections.

1. Historical Performance & Variable Input Analysis

Historical Analysis is the starting point for projecting a firm's future performance and financial condition. This is the basis for projecting a firm's performance under future conditions. Identification of key variables influencing the company is the main tool in building financial projections. The analyst should be able to determine what has probably caused the historical results. This should be supplemented with information about future conditions provided by statistical organizations, industry projections or company plans.

Using this information, the analyst can begin to make assumptions as to what future events may occur and how these events will affect the firm's future performance. Normally, the analysts use financial statements over a minimum of three (and preferably five) years to examine a firm's historical performance.

2. Summary of Analysis of Company's Performance

The analyst should summarize his analysis of the company's performance before beginning projections.

1. Is the company operationally healthy? (OP, OPM, EBIDTA)

2. Is the company financially strong or too highly leveraged? ( D/E Ratio, Interest Coverage Ratio)

3. Are markets growing, stable or shrinking? (Industry Growth)

4. How is the company situated amongst the competitors? (Market Share)

5. A summary of present financial condition and existing cash flow.

6. Strengths and weaknesses in management, industry position, nature of products and attendant risks, economic cyclicality.

7. Management Performance as an influencing variable.

8. Operating Risks.

9. Historical Spreadsheets.

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Prof. Gangineni Dhananjhay holds B.Tech., MBA, NCFM (CFA) qualifications, and is currently Assistant Professor - Finance in the M.B.A. Department at Vivekananda School of P. G. Studies (VSPGS), Hyderabad.