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CHAPTER 5

Financial Statement Forecasting, Financial Analysis, and Valuation

In Chapter 4 we learned how to conduct a historical performance analysis and determine if a stock was a good candidate for promotion into our more thorough analysis process—the one we implement when we're thinking about publishing a report on the stock in support of a buy or sell decision that would change our portfolio holdings. We ran McDonald's (MCD) through the Chapter 4 historical performance analysis and the stock scored 91 percent on our performance diffusion index. We will therefore extend the MCD example in this chapter.

After all the metrics we considered in Chapter 4, you might be wondering what's left to study. Even though the historical performance analysis was thorough, the main problem with stopping at that point is that most of the analysis is backward-looking. Except for the free cash flow valuation model, all we did was interpret how MCD had been performing in recent years. Additionally, the Chapter 4 free cash flow valuation model was limited by the assumption that the company was already in slow-growth mode. We need a forward-looking model that allows us to consider the validity of this and other assumptions regarding the most likely future trajectory of the company we're analyzing.

In this chapter we work with a model that will allow us to forecast the key drivers of the company's income statements and balance sheets based on the trends we observe in the historical analysis, and value ...