Consider the following two earnings forecasting models:
Model 1 Et(EPSt+1) = EPS t
Model 2 Et(EPSt+1) =
Et(EPSt+1) is the expected forecasts of earnings per share for year t+1, given information available at t. Model 1 is usually called a random walk model for earnings, whereas Model 2 is called a mean-reverting model. The earnings per share for TJX for the fiscal years ending January 2006
(FY2005) through January 2010 (FY2009) are as follows:
Fiscal Year 2005 2006 2007 2008 2009
EPS 1.40 1.60 1.70 2.00 2.80
a. What would be the forecast for earnings per share in FY2010 for each model?
Model 1 (random walk model):
Model 2 (mean-reverting model):
b. Actual earnings per share for TJX in FY2010 were $3.30. Given this information, what would be the FY2011 forecast for earnings per share for each model? Why do the two models generate quite different forecasts? Which do you think would better describe earnings per share patterns? Why?
Model 1:
Model 2: