Security Analysis and Business Valuation on Wall Street,: A ... - lib

190 PERFORMING THE ANALYSIS AND WRITING THE RESEARCH REPORT282420Billions of Dollars1612840SalesEarningsA realistic analyst expects the cyclical company’s futureresults to be uneven.EXHIBIT 11.7Long-Term Cyclical Company Forecastthe 2008 projection maintained that things were different this time. Entertainingthe notion that Huntsman can escape the chemical commodity cycle is speculativeindeed.A more practical approach is provided by a veteran steel analyst Jim Rudolph:“You know there’s going to be a downturn for these capital-intensive companies, soyour forecast has to show the effects of the waves (of economic prosperity) comingin <strong>and</strong> out.” Thus, while the overall sales trend over the future cycles moves upward,it is interrupted periodically with a couple of down years. If one assumes a repetitiveseven-year cycle for aircraft orders, then Huntsman’s revenue tops out in 2008, tobe followed by a couple of years of 15 percent declines.The same rationale is appropriate for the larger universe of cyclical enterprises,which includes most capital goods <strong>and</strong> consumer durables companies. Assuming theunderlying business shows promise, the relevant sales <strong>and</strong> earnings forecast shouldlook something like Exhibit 11.7.HOCKEY STICK PHENOMENONThe hockey stick phenomenon occurs as follows: (1) A professional evaluates asteadily growing business <strong>and</strong> makes a financial projection; (2) in order to justifyan investment recommendation, he kick-starts the company’s earnings the year afterthe investment starts; <strong>and</strong> (3) others use his forecast to sign off on the recommendedstock, which otherwise appears overpriced. Graphically, the optimistic projectionresembles a hockey stick. See Exhibit 11.8.Hockey sticks are most prevalent in the latter stages of a bull market, sinceinvestors make increasingly optimistic assumptions in order to rationalize the