The impact of diversification on industry effects in firm profitability forecasting

In this paper, we revisit the relative forecasting improvement from the use of an industry-specific model compared to that of an economy-wide model. We extend the results of Schröder and Yim (2018) who demonstrate that the industry-specific model only improves forecasting for single-segment firms due to the complication of different industries confounding the industry benchmark for multiple-segment firms. To explore the issues, we argue that the level of diversification, defined as the proportion of revenue of a firm derived from its largest segment, is a more nuanced manner than a simple single-/multiple-segment dichotomy. Our results suggest that industry-specific models can provide more accurate forecasts of future performance and growth, not only for single-segment firms, but also for multiple-segment firms where the level of diversification is relatively low. The results help contribute to the forecasting literature to further explain when the use of different benchmarks is useful in predicting future performance.