Projections Beyond the Short-term Fore ...
Analysts use three approaches to project future revenue.
The top-down approach begins at the level of the overall economy. Forecasts are then narrowed to such levels as sector, industry, and market for a specific product. This helps in the attainment of a revenue projection for an individual company.
Two top-down approaches to modeling revenue are growth relative to GDP and market growth and market share.
In a growth relative to the GDP growth approach, an analyst forecasts the GDP growth rate. They then consider how the growth rate of the specific company being examined will compare with GDP growth. The analyst may forecast real GDP growth to project volumes and a forecast for inflation to project. It’s noteworthy that an analyst may conclude that a company’s revenue will grow at a rate of 200 bps above the GDP growth rate. Alternatively, in relative terms, they may conclude that the company’s revenue will grow at a 15% rate faster than the GDP growth rate.
In a market growth and market share approach, an analyst forecasts growth in a particular market. They then consider a company’s market share and how it is likely to change over time. Assume that a company is expected to maintain an 8% market share for a given product, and the product market is forecast to grow from $18.75 billion to $20 billion in annual revenue. In that case, the forecast company revenue is $1.6 million.
The bottom-up approach begins at the individual company or unit level. It then aggregates the individual company/unit projections to arrive at a forecast of total revenue for the company. Analysts also aggregate the revenue projections for individual companies to develop a forecast for a product market, industry, or the overall economy.
Bottom-up approaches to modeling revenue include:
The hybrid approach combines features of both top-down and bottom-up approach analyses and is the most commonly used approach. An analyst may use the market growth and market share approach to model individual product lines and then sum up the individual projections to forecast the overall company.
The approach of projecting revenues that begins at the individual company level, then aggregates the company’s projections to arrive at the industry revenue is most likely the:
- Bottom-up approach.
- Growth relative to GDP growth approach.
- Market growth and market share approach.
The correct answer is A.
The bottom-up approach is a revenue projection method that begins at the individual company level and aggregates the revenue of the companies in the industry to arrive at the industry revenue figure.
B is incorrect. Growth relative to GDP growth is a top-down approach that begins by forecasting the GDP growth rate of the overall economy and then estimating the growth rate of an individual company relative to the GDP growth rate.
C is incorrect. Market growth and market share is a top-down approach that begins by forecasting the growth in a particular market and then estimating the company’s market share and how it is likely to change over time.
Reading 17: Financial Statement Modeling
LOS 17 (b) Compare “growth relative to GDP growth” and “market growth and market share” approaches to forecasting revenue.
The two major valuation models that are based on the going concern assumption... Read More
When the market price per share is greater than its book value, the... Read More