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NISM Certifications · NISM-Series-XV: Research Analyst · Fundamentals of Research

A company's earnings per share over four years were Rs 10, Rs 12, Rs 15 and Rs 18. An analyst fits a regression of EPS on time and finds a strong positive slope and a very high R-squared of 0.98. Which conclusion is MOST appropriate?

The right conclusion is that the trend explains most historical variation, yet forecasting from it stays uncertain. R-squared measures in-sample fit, not causation or future accuracy, and four observations are too few to treat the slope as guaranteed to continue.

  1. AFuture EPS is guaranteed to rise at the same slope
  2. BThe linear trend explains most of the historical variation, but extrapolation remains uncertain given only four observations and changing conditionsCorrect
  3. CThe high R-squared proves that time causes earnings to grow
  4. DR-squared of 0.98 means 98% of future forecasts will be accurate

Explanation

R-squared shows the share of variation in the sample explained by the fitted line, not causation or guaranteed future accuracy. With just four data points and potentially changing conditions, extrapolation is uncertain.

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