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Focusing on data can enhance business forecasting, Houston researcher finds

A new, data-intensive technique can create a better profile of a firm and its profit forecast. Photo via Pexels

Earnings summaries are the corporate version of a Magic 8 Ball, something used to forecast future performance and profit. But Rice Business professor Brian Rountree has found that magic has its limits, and that by delving into a few additional areas of interest, investors can get a more accurate prediction of a company's future earnings than current techniques allow.

Plenty of studies analyze how to use performance summaries to calculate a firm's potential and future profits. Building on the abundant literature around this approach, Rountree, working with colleagues Andrew B. Jackson of the UNSW Australia Business School and Marlene Plumlee of the University of Utah, devised a new, additional technique for forecasting profits. By dissecting an assortment of operating details, the researchers discovered, it's possible to create a more precise forecast of a company's financial future.

Rather than replacing prior work on the subject, Rountree's team delved deeper into the significance of details within existing data. Their focus: whether including a firm's market, its overall industry and any unique activity specific to the firm makes for a more reliable profit forecast. Their conclusion: Firms can indeed improve their predictions if they separate returns on net operating assets (RNOA) into separate components and use those figures in their projections.

Normally, firms use market and industry related data to create future profit predictions. For example, a major oil company might use data on market conditions and the overall state of the oil industry to build its profits prediction. The resulting financial literature might be peppered with statements such as, "Like the rest of big oil…" or "The overall market for oil remains soft."

While this type of data is typically used to make projections, Rountree and his colleagues used the market and industry information more formally by creating the equivalent of stock return betas — a statistical measure of risk — for corporate earnings. In addition, they allowed for adding firm-specific information to market and industry information to help forecast earnings.

To conduct their study, Rountree's team used Compustat quarterly data to calculate firm, industry and market RNOAs from 1976 to 2014. Next, they broke these figures down and separated the results into different categories.

Their resulting formula differs from the conventional approach because it doesn't rely on one average set of market and industry-related data for each firm. Instead, it assumes varying factors for each company. The devil is in these details: Calculating specific market, industry and firm-idiosyncratic components improves the chances of forecasting profits correctly.

Correctly breaking down and separating profitability details to plug into the new formula is no small task. Separating company data into just three components requires up to 20 quarters of figures about prior profitability.

Once the information is processed, a researcher must then be vigilant for "noise" — incidental, irrelevant data that can lead to errors. Finally, Rountree warns, the breakdown process may not work as well for forecasting bankruptcy as it does for profits.

Used correctly, however, the technique is a practical new tool. By breaking down profitability into market, industry and firm-specific idiosyncrasies, researchers can improve forecasts strikingly compared to conventional calculations of total RNOAs.

The most accurate profit forecasts in other words, demand more than just a figurative shake of an industry Magic 8 Ball. To find the most reliable information about future earnings, a company instead has to flawlessly juggle years' worth of specific details about their particular firm. But the reward of planning based on a correct forecast can pay for itself.

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This story originally ran on Rice Business Wisdom. It's based on research by Brian Rountree, an associate professor of accounting at Jones Graduate School of Business at Rice University.

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Building Houston

 
 

Cheers Health has expanded its product line as it evolves as a wellness-focused brand. Photo courtesy of Cheers

Houston-based startup Cheers first got a wave of brand devotees after it was passed over by investors on Shark Tank in 2018. In the years since, Cheers secured an impressive investment, launched new products, and became a staple hangover cure for customers. When the COVID-19 pandemic disrupted businesses, the company rose to the occasion and experienced its first profitable year as drinking and wellness habits changed across America.

Cheers initially started its company under the name Thrive+ with a hangover-friendly pill that promised to minimize the not-so-fun side effects that come after a night out. The capsules support the liver by replacing lost vitamins, reduce GABAa rebound and lower the alcohol-induced acetaldehyde toxicity levels in the body. The company's legacy product complemented social calendars and nights on the town, providing next day relief.

With COVID-19 lockdowns and social distancing measures, the days of pub crawls and social events were numbered. Cheers founder Brooks Powell saw the massive behavior change in people consuming alcohol, and leaned into his vision of becoming more than just a hangover cure but an "alcohol-related health company," he says.

When the pandemic first hit, Powell and his team noticed an immediate dip in sales — a relatable story for businesses in the grips of COVID-19.

"There is a three day period where we went from having the best month in company history to the worst month in company history, over a 72 hour stretch," he remarks.

He soon called an emergency board meeting and rattled off worst-case "doomsday" scenarios, he says.

"Thankfully, we never had to do any of these strategies because, ultimately, the team was able to rally around the new positioning for the brand which was far more focused on alcohol-related health," he says.

"We found that a lot less people were getting hangovers during 2020, because generally when you binge drink, you tend to binge drink with other people," he explains.

He noticed that health became an important focus for people, some who began to drink less due to the lack of social gatherings. On the contrary, some consumers began to drink more to fill the idle time.

According to a JAMA Network report, there was a 54 percent increase in national sales of alcohol for the week stay-at-home orders began last March, as compared to the year prior.

"All of a sudden, you have all of these people who probably aren't binge drinking but they're just frequently consuming alcohol. Their drinks per week are shooting up, and they're worried about liver health," explains Powell.

Outside of day-after support, Cheers leaned into its long-term health products to help drinkers consume alcohol in a healthier way. Cheers Restore, a dissolvable powder consumers can mix into their water, rehydrates the body by optimizing sodium and glucose molecules.

For continued support, Cheers Protect is a daily supplement designed to increase glutathione — an antioxidant that plays a key role in liver detoxification — and support overall liver health. Cheers Protect, which was launched in 2019, became a focus for the company as they pivoted its brand strategy and marketing to accommodate consumer behavior.

"The Cheers brand is just trying to reflect the mission statement, which is bringing people together through promoting fun, responsible and health-conscious alcohol consumption," says Powell. "It fits with our vision statement, which is a world where everyone can enjoy alcohol throughout a long, healthy and happy lifetime,."

At the close of 2020, Cheers had generated $10.4 million in revenue and over $1.7m in profit — its first profitable year since launch.

During the brand's mission to stay afloat during the pandemic, the Cheers team was also laying the groundwork for its entry into the retail space. When Powell launched the company during his junior year at Princeton University, bringing Cheers to brick-and-mortar stores had always been a goal. He envisioned liquor and grocery stores where Cheers was sold next to alcohol as a complementary item. "It's like getting sunscreen before going to the beach, they kind of go hand in hand," he says.

"When we spoke with retailers, specifically bars and liquor stores, what we learned is that a lot of these places were hesitant to put pills near alcohol," he says. Wanting an attractive and accessible mode of alcohol-support, the Cheers team created the Cheers Restore beverage.

Utilizing the technology Cheers developed with Princeton University researchers, the Cheers Restore beverage incorporates the benefits of the pill in a liquid, sugar-free form. The company states that its in-vivo study found that the drink is up to 19 times more bioavailable than pure dihydromyricetin (DHM), a Japanese raisin tree extract found in Cheers products and other hangover-related cures.

"What we figured out is that if you combine DHM — our main ingredient — with something called capric acid, which is an extract from coconut oil, the bioavailability shoots way up," says Powell. He notes the unique taste profile and the "creaminess" capric acid provides. "Now you have this lightly carbonated, zero-sugar, lemon sherbert, essentially liver support, hangover beverage that tastes great in 12 ounces and can mix with alcohol," he explains.

The Cheers Restore beverage is already hitting the Houston-area, where its found a home on menus at Present Company. The company has also run promotions with Houston hangouts like Memorial Trail Ice House, Drift, and The Powder Keg.

Currently, the beverage is only available in retail capacity and cannot be ordered on the Cheers website. As Powell focuses on expanding Cheers Restore beverage presence in the region, he welcomes the idea of expanding nationally in the future to come. While eager customers await the drink's national availability, they can actively invest in Cheers through the company's recently-launched online public offering.

Though repivoting a company and launching a new product is exciting, the process did not come without its caveats and stressors. While Cheers profited as a business in 2020, the staff and its founder weren't immune to the struggles of COVID-19.

"I think 2020 was the first year that it really became real for me that Cheers is far more than just some sort of alcohol-related health brand and its products," says Powell. "Cheers is really its employees and everything that goes into being a successful, durable company that people essentially bet their careers on and their family's well-being on and so forth," he continues.

"It really does weigh on you in a different way that it's never weighed on you before," says Powell, describing the stress of the pandemic. The experience was "enlightening," he says, and he wants others to know it's not embarrassing to need help.

"There is no lack of great leaders out there that at long periods of their life they needed help in some way," he says. "For me that was 2020 and being in the grinder and feeling the stress of the unknown and all of that, but it could happen to anyone," he continues.

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