CFA Level I · CFA Level I Exam · Financial Statement Forecasting in Equity Valuation
An analyst builds a revenue forecast for a manufacturer by extrapolating the growth rate of the most recent strong year indefinitely. Which forecasting pitfall is the analyst most likely committing?
The analyst is most likely overrelying on recent trends. Extrapolating a single strong year's growth indefinitely ignores mean reversion, competitive responses and the business cycle, which usually pull growth back toward long-run norms, so the forecast is biased upward.
- AOverreliance on recent trendsCorrect
- BExcessive use of scenario analysis
- CIgnoring the sensitivity of output to inputs
Explanation
Projecting one strong year's growth forward indefinitely ignores mean reversion, competition and the cycle. That is a classic error of overweighting recent performance. Scenario analysis and sensitivity testing are not what the analyst is doing wrong here.
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