Residual Autocorrelation
The autocorrelation of a time series refers to the correlation of that time... Read More
The forecast time horizon is influenced by the following:
Longer-term projections often represent normalized earnings better than short-term forecasts when there are temporary items. Normalized earnings reflect mid-cycle earnings for a firm after excluding any unusual or temporary factors.
Question
Which of the following is least likely a factor influencing the forecast time horizon?
- The investment strategy.
- The cyclicality of the industry.
- Dividends.
Solution
The correct answer is C.
Dividends are not a factor to consider when considering the forecast time horizon. However, there is a possibility that an employer might require the use of a dividend discount model, yet, the company under evaluation does not, at the time of evaluation, pay dividends because it is not profitable. In such a case, the analyst forecasts need to include a period where the company becomes profitable and resumes dividend payment.
A is incorrect. The investment strategy is one factor that influences the forecast time horizon. Professionally managed equity investments have an investment timeframe or the average holding period for a stock, corresponding with the average annual portfolio turnover.
B is incorrect. The industry’s cyclicality is a factor that influences the forecast time horizon. The forecast period should be long enough to allow the business to reflect average mid-cycle levels of revenue and profits.
Reading 17: Financial Statement Modeling
LOS 17 (m) Explain considerations in the choice of an explicit forecast horizon.