Around a third of U.S. public companies provided earnings guidance ― managers’ forecast of forthcoming earnings ― either quarterly and/or annually pre-pandemic. Roughly half of these companies stopped the guidance in 2020, claiming that the heightened business uncertainty, particularly regarding the return to normal operations, precludes them from providing an earnings forecast. Makes sense. Now, many of the guidance secessionists are returning to the fold and the panic about guidance has resumed.
Earnings guidance expanded in recent years to guidance about other fundamentals, like revenues, the number of new customers (Netflix (NFLX), for example), or new oil explorations. The guidance practice is highly attractive to investors and financial analysts, as is clearly evident by extensive research – which shows, among other things, the following:
- When guidance is published – usually with the earnings release or in the following earnings (conference) call – investors’ reaction to the guidance, in terms of share price change, is far larger than is their reaction to the earnings (or revenue) news.
- Companies that ceased guidance (pre-pandemic) suffered a share price loss and desertion of some analyst following.
- Investors respond more to managerial earnings guidance than they do to analysts’ revisions of earnings estimates. And when guidance is provided, most analysts quickly revise their earnings estimates in the direction of the guidance.
So, the earnings guidance issue seems a no-brainer. Investors welcome quantitative, forward-looking key information from executives, in sharp contrast with the historical, stale, and often irrelevant information in quarterly and annual financial reports. Nevertheless, the earnings guidance issue is highly controversial.
Respected business organizations, like the Chambers of Commerce and the Conference Board; leading investors, like BlackRock CEO Larry Fink; and pundits, including Al Gore, vent their ire over earnings guidance. They demand in white papers and open letters to CEOs that the procedure will be stopped, particularly the quarterly version.
Why? You ask. I will spare you the boring details by giving the essence of the guidance complaint and my opinion.
Guidance enhances the short-term, myopic focus of executives. This claim doesn’t make sense. First, there is no credible evidence of widespread managerial myopia. People who spend $450 billion a year on a long-term and uncertain investment like R&D, and even a larger amount on IT, cannot be considered myopic. Second, and more to the point, abstaining from guidance doesn’t free you from analysts’ quarterly earnings and revenue estimates, which most CEOs and CFOs do their best to meet, or better yet beat. Google (Alphabet) (GOOGL) (GOOGL) doesn’t provide quarterly guidance, yet it is still followed by three scores of analysts who provide quarterly earnings estimates which, when missed, results in a hit to the stock price. With this focus on quarterly earnings, how does the provision of earnings guidance enhance managers’ alleged short-termism?
Guidance is a waste of managers’ time and attention. This is bizarre. Executives who don’t have ongoing quarterly, annual, and long-term operational budgets and forecasts, from which guidance can easily be derived, shouldn’t manage businesses.
Guidance doesn’t increase long-term share value. Generally true, but that’s not the objective of guidance. Guidance is intended to share with investors early information available to managers to improve their decisions and soften the shock of large earnings/revenue surprises. Guidance improves transparency in capital markets.
So, in my opinion, the arguments against earnings guidance aren’t convincing, and I wholeheartedly welcome the return of guiders who ceased the practice during the pandemic. I hope that not many executives will exploit the pandemic guidance secession period and stealthily abstain from resuming guidance.
What should investors know about managerial guidance? The following conclusions are based on extensive research:
- While a few earnings/revenue/subscriber-growth guidance are slightly optimistic, the large majority are credible and relevant information sharing, worthy of inclusion in your investment decisions. But get the new guidance quickly from the earnings release or from the subsequent earnings call. It stales quickly.
- Guidance is informative about the future operations of the company, and even medium- to long-term (three to five years) guidance was found to improve the forecasts of the company’s long-term operating performance.
- The fact that a company provides guidance doesn’t imply that its executives are myopic. In fact, one study found that guidance provision is positively associated with more innovation and higher quality of patents.
- A large sample reports that guiding firms provide more credible (high-quality) earnings, concluding: “Managers who provide guidance are less likely to manage [manipulate] earnings.” Another study concluded: “Our results indicate that firms with higher quality IPO information are more likely to provide early [first year] earnings guidance.”
- Guiding companies have less volatile earnings and smoother analysts’ estimates.
So earnings, and better yet, more fundamental guidance ― on revenues, new subscribers, forthcoming investments, or product deliveries ― is an important information that should be generally factored into your investment decisions. All other things equal, guiding companies are preferable to non-guiders.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Note: This post was first published here at SeekingAlpha.com on Mar. 16, 2021.