We will save most of the discussion on future earnings for our later lesson focusing exclusively on valuing a business. As a caveat, let's cover some of the basic principles:
1. The greatest indicator of the future is the past. If a company has grown at 4% for the past ten years, it is very unlikely it will start growing 6-7% in the future short of some major catalyst. You must remember this, and guard against optimism. Your financial projections should be slightly pessimistic at worst, outright depressing at best. Being masochistic in finance can be very profitable. A Pollyanna-like disposition can cream your personal balance sheet in the long-run.
2. Companies involved in cyclical industries such as steel, construction, and auto manufacturers are notorious for posting $5 earnings per share one year and -$2.50 the next. An investor must be careful not to base projections off the current year alone. He / she would be best served by averaging the earnings over the past tens years, and basing coming up with a valuation based on that figure. For more information, read Valuing Cyclical Stocks: Assigning Intrinsic Value to Businesses with Unsteady Earnings.
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This page is part of Investing Lesson 4 - How to Read an Income Statement. To go back to the beginning, see the Table of Contents.
