4

Taming the Future

There is nothing wrong with change, if it is in the right direction.

—Winston Spencer Churchill (1874–1965), British statesman

CHAPTER 3 DEALT WITH THE FRAMEWORK for establishing fair values. Those, like all forms of value, are based on what is expected to happen. This chapter covers what management can do to tame the future. It makes its best guesses in budgets, forecasts, and business plans for presentations to staff, directors, analysts, and investors. But none of those give fair values, which are based not on what management anticipates, but on what market participants expect. Although many practitioners use budget figures for the current year as a base, reference should be made to analysts' reports on comparables whenever possible. This practice tends to limit expected growth to that of the industry as a whole and probably will reflect a reversion to the mean, rather than a continuation of past favorable trends.

When a turnaround is involved, market participants tend to be pessimistic, expecting more time, greater investment, and lower returns than management does. Alternatively, they can be overly enthusiastic, willing to pay what may appear to be excessive premiums for growth.

One measure used by analysts is the price/earnings to growth (PEG) ratio. If an entity has a price to earnings ratio (PER) of 12.5 times based on reported profit of the latest 12 months (LTM) and excellent projected earnings growth of 7.5% a year, the PEG ratio is 1.67 times (12.5/7.5); ...

Get The Professional's Guide to Fair Value: The Future of Financial Reporting now with the O’Reilly learning platform.

O’Reilly members experience live online training, plus books, videos, and digital content from nearly 200 publishers.