Ferri: Value In CFO Returns Predictions

July 09, 2015

Tune into any financial news network and you’ll hear a continuous drumbeat of Wall Street analysts spouting their most recent stock market forecast. I find there is value to these forecasts—entertainment value—especially from the forecasters who foresee grandiose returns or impending doom.


In terms of investment value, if these forecasts serve any point at all, it’s to illustrate how far some forecasters will go to get media attention.


Perhaps a more useful stock market forecast is how chief financial officers (CFOs) of publicly traded companies view future stock returns. We’re not implying that investors should slavishly react to the quarterly forecasts of CFOs any more than they should react to any other moving forecasts. But passively minded investors can use these numbers to estimate what their portfolio’s return might be given different asset allocations.


Company boards make capital decisions based in part on their CFOs’ assessments of the cost of equity, and these decisions have an impact on future returns in the equity market. Company boards may issue new stock to take on new projects when they believe the cost of equity capital is low (stock price is high), and may buy back stock to reduce share count when the cost of equity is high (stock price is low). These decisions affect long-term valuations.


Duke University and CFO Magazine conduct the Global Business Outlook Survey each quarter to find out what CFOs think about a lot of economic factors, including their forecasts for interest rates, growth, inflation, the price of oil and stock market returns. Duke professors John Graham and Campbell Harvey analyzed the data from the March 2015 survey to determine a 10-year equity risk premium forecast, which is the excess return the stock market is expected to earn over a risk-free rate. They published their findings in a paper titled The Equity Risk Premium in 2015.


The Value Of Expected Returns

Figure 1 is from Graham’s and Harvey’s paper. It highlights the average annualized 10-year expected annualized S&P 500 return forecasts from the Global Business Outlook Surveys conducted from second quarter 2000 through first quarter 2015. The mean CFO forecast using the March data was 6.63 percent over the next 10 years, which is slightly higher than the previous forecasts.


Figure 1: 10-year Forecast through March 2015

Source: Graham, John R. and Harvey, Campbell R., The Equity Risk Premium in 2015 (June 24, 2015). Available at SSRN: http://ssrn.com/abstract=2611793 or http://dx.doi.org/10.2139/ssrn.2611793


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