Stock analysts need to forecast revenue and growth to project what expected earnings will be. Forecasted revenue and growth projections are important components of security analysis. often leading to a stock’s future worth. For example, if a company shows a high rate of growth over several periods, it will command multiples that exceed the market multiple. When its forward multiple increases, its stock price should consequently increase, resulting in a higher return for investors. Making forward projections requires numerous inputs; some come from quantitative data and others are more subjective. The reliability and accuracy of the data drive the forecasts.

Forecasting Revenue

Modeled revenue and growth will be mostly reliable if the inputs used to determine them are as close to accurate as possible. To forecast revenue, analysts gather data from the company, the industry, and consumers. Typically, both companies and industry trade groups publish data related to the potential size of the market, the number of competitors, and current market shares. This information can be found in annual reports and through industry groups. Consumer data ascertained from buyer surveys, UPC barcoding, and similar outlets paint a picture of current and future expected demand.

Further inputs are needed to specifically model a company’s revenue forecasts. Financial statements, such as the balance sheet. inform analysts of a company’s current inventory and changes in inventory levels from one period to another. Often companies will also provide updates on inventory, shipments, and expected number of unit sales in the current period.

Average price-per-unit can be calculated using the revenue provided in the income statement divided by the change in inventory (or number of units sold). For past transactions, these data can found in a US company’s Securities and Exchange Commission reports, but for future transactions, assumptions are required—assumptions such as the impact of competition on pricing power and expected demand versus supply.

In competitive markets, prices usually fall, either directly through price cuts or indirectly in the form of rebates. Competition comes in the form of similar products by different manufacturers, or new products entering and cannibalizing old ones. When supply exceeds demand, companies usually push products to the consumer, typically resulting in lower price points. Forecasted revenue is calculated by taking the average selling price (ASP) for future periods and multiplying that by the number of expected units sold. These calculated forecasts can be “confirmed” by company management, who may discuss revenue and its expectations for growth on conference calls, usually scheduled around the release of the latest annual or quarterly report. Additionally, company management may participate in intra-period events, such as industry conferences, where they may release new information on inventory, market competitiveness, or pricing to confirm or assist in building revenue models.

Forecasting Growth

Once revenue is determined, future growth can be modeled. Applying a growth rate on revenue can help determine the future earnings growth. Setting the appropriate growth rate will be based on expectations about product price and future unit sales. Penetration into new and existing markets and the ability to steal market share will impact future unit sales. Industry outlook, analyzing the key product features, and demand are integral components to forecasting growth rates.

Let’s look at a simple example: Company ABC starts with $100 in revenue. They are expected to grow in-line with the market. Company ABC is forecasting its ability to increase market share and set prices. Here is their forecast: