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Measure Earnings Predictability in Excel

Calculating R-Squared for a company’s earnings is one way to measure stock quality and risk.

Higher earnings increase the value of a company, which eventually increases a stock’s price when investors realize the stock is worth more. How much the stock price increases depends on perception as much as reality. The stock market hates uncertainty, which is why investors usually pay more for companies that pump out consistently increasing earnings. Predictable earnings represent more safety—a greater chance of a higher stock price as the earnings increase steadily year after year. They also mean that company management is competent, successfully playing the problems and opportunities that every company is dealt. Although statistics are often maligned for twisting the meanings of numerical results, you can confidently apply the standard statistical function R-Squared to evaluate the predictability of a company’s past earnings, and from that forecast its future earnings. Microsoft Excel makes this even easier with a built-in function that returns R-Squared as one of its results.

Getting the Earnings Data You Need

To measure earnings predictability, you need some earnings data. You should look for companies with at least five years of earnings, because you can’t see meaningful trends with fewer years. To analyze earnings, use earnings per share (EPS), which illustrates how many dollars of earnings one share of stock generates. EPS is more meaningful ...