Have you ever wondered where “expert” investment opinions come from? Who is behind the numbers and giving us the suggestions of whether or not to buy stock? Is it computerized or are there humans doing the calculations? Is it possible for humans to do these calculations? Lastly, are these predictions even accurate?
What many people who visit the expert opinions tab on search engines such as MSN Money, Yahoo Finance, CNBC, etc. do not know is what it takes to come up with these numbers and predictions. Although different search engines display their data findings and suggestions differently, they all get their information from the same process. This process is called a discounted cash flow analysis of a company. In order to forecast the future of a company, value the company, and predict whether or not someone should buy their stock, analysts must familiarize themselves with not only the company history, but the industry as well. This will allow the analyst to then make a five-year forecast for the company to the best of their knowledge. The most accurate way to create this five-year forecast is to create an income statement and balance sheet that is linked to ratios. That way, when forecasting, the analyst can simply predict the future ratios for the next five years and from there, calculate income statement and balance sheet values from there. These ratios will be easy to predict when given the historical ratios and when the analyst has a good sense of the industry and company history. Once this five-year period is predicted, the next step is to create a transition period for the company until the growth rate becomes pretty constant. With a new and growing company, this transition period will be a lot longer since the present growth rate is likely high. This transition period can last anywhere between 5 and 25 years. Once this transition period is predicted and the growth rate is constant, the analyst looks for the forecasted free cash flow values. They use this to come up with the net present value of the company, including perpetuity of the last year they forecasted. This net present value for the company can then be used to predict share values by dividing it by the current number of shares. Through playing with different discount rates and growth rates, analysts can easily manipulate the data to change this predicted value.
Are There Humans Behind Search Engine Predictions?
To answer our initial questions, yes, there generally are humans behind the search engine predictions. However, there are definitely formulas that can be used to solve most of these calculations. When determining whether or not these predictions are accurate, you must consider many factors. You must first look at who is doing the analysis. Is the analyst getting paid by the company that they are analyzing? Are they getting paid at all? Do they have any other incentive to manipulate the data in any way? Most analysts are optimistic when it comes to analyzing a company. Not only is it in the best interest of the company to have good analyst ratings, but it makes the analyst look better as well. Another factor to consider is that of Groupthink. If every analyst out there is a little too optimistic, and you are the only accurate or pessimistic analyst, people are less likely to value your opinion.
So next time you view analyst opinions online, remember the “behind the scenes” calculations that go into the prediction. Most importantly, remember how easy it is to skew data and be sure to do your own research as well!