Executives and investors often use analysts’ consensus estimates and industry multiples to determine the value of companies. Research shows, however, that analysts’ near-term forecasts are often overly optimistic and don’t always correctly reflect operating performance.1
Business leaders and investors need to know what analysts include or exclude in their forward-looking estimates of performance and how those estimates compare with actual results in the past. They should therefore pay special attention to the operating items that most directly affect corporate value, such as stock compensation expenses or large joint-venture or equity investments.
Business leaders at one technology company, for instance, noticed a marked difference between their own and analysts’ estimates of EBITA margins. It turned out that analysts’ forecasts didn’t consider stock compensation expenses as operating expenses—hence the different projections. Taking this difference into account, business leaders at the company were able to bring analysts’ estimates into line with historical trends (exhibit).
Even if analysts’ estimates are relatively accurate, business leaders may want to use a discounted-cash-flow model rather than apply industry multiples to account for inevitable changes in an industry over time.
1. Tim Koller, Rishi Raj, and Abhishek Saxena, “Avoiding the consensus earnings trap,” McKinsey, January 1, 2013.
David Kohn is a senior knowledge expert and associate partner in McKinsey’s New York office, where Vartika Gupta is a research science expert. Tim Koller is a partner in the Denver office. Werner Rehm is a partner in the New Jersey office.
For a full discussion of this topic, see Tim Koller, Marc Goedhart, and David Wessels, Valuation: Measuring and Managing the Value of Companies, seventh edition, Hoboken, NJ, Wiley Finance, 2020.