The Case for Earnings Guidance
from
September/October 2003
by Randy Myers
To companies that have struggled to meet their own earnings projections, Coca-Cola Co.’s decision last year to stop issuing quarterly and annual earnings guidance may have looked like a masterstroke. Eliminate expectations and you eliminate the pressure to meet them. If you can shift investor attention away from your company’s short-term earnings targets, you can refocus it where it belongs, on the long term.
While those arguments have an appealing logic—and hey, they were good enough for Warren E. Buffett, who sits on Coke’s board and controls 8% of its stock through his investment company, Berkshire Hathaway—they don’t necessarily mean that your company should follow Coke’s lead (or, for that matter, McDonald’s or AT&T’s). Withholding information you once routinely provided to Wall Street can be a risky move, especially in the current climate of investor skepticism. Numerous high-profile accounting scandals have left investors clamoring for more information, not less. “The market likes visibility and transparency,” says Jeffrey Evans, immediate past president of the New York Society of Security Analysts. “To the extent providing guidance assists that, I think it’s favorable.”
Most public companies agree. In a survey of its members earlier this year, the National Investor Relations Institute found that 78% of the responding companies were issuing some form of earnings guidance. Of those, 75% gave an earnings-per-share range, 63% provided revenue information, 11% issued specific earnings-per-share projections, and 8% revealed their earnings models. (Some outfits provided more than one type of data.) Among the companies that issued guidance, however, 28% said they were considering whether to stop doing so.
For those 28%, as well as any closet doubters, here are three good reasons why you should consider keeping earnings guidance as part of your act:
1. Guidance builds credibility.
Especially for smaller companies that have no coverage from sell-side securities analysts, issuing earnings forecasts and meeting them is a smart way to win the confidence of Wall Street’s buy side. Brad Allen, vice president for investor relations and corporate communications at Imation Corp., a maker of digital data-storage media, says that the company was left without sell-side coverage about two years after its 1996 spin-off from 3M. But it was able to stabilize its shareholder base, he says, by issuing highly detailed earnings projections that included forecasts for major line items such as revenues, gross margins, discretionary spending, operating income, and the company’s tax rate. Imation packaged that information prominently in its quarterly earnings press releases. After the company finally did pick up some sell-side coverage, says Allen, its officers and directors reconsidered its practice of issuing detailed guidance. They concluded that since they were prepared to do so if questioned by investors and analysts in their conference calls following each quarterly earnings release, it made no sense not to continue volunteering that information.
2. Guidance can prevent nasty surprises.
Companies that fail to meet Wall Street’s earnings expectations routinely get hammered in the stock market. A lack of guidance raises the odds of such a negative surprise. “To expect an analyst to come up with an independent quarterly estimate that’s meaningful, compared with what the company can provide, is ridiculous,” says Chuck Hill, director of research at Thomson First Call, a research and consulting firm that tracks analysts’ earnings estimates. “The company is looking at their books of what’s already happened in the quarter. The analyst doesn’t have that.” Hill adds that issuing earnings guidance for periods beyond the current quarter is different. In those cases, he says, companies should not give explicit guidance but should provide analysts with the data to make their own calculations.
3. Guidance gives management more control.
Big negative earnings surprises raise questions about management’s competence. “The immediate reaction from investors,” says Hill, “is ‘You mean you folks didn’t know until now? What kind of internal controls do you have?’” More important, guidance puts management, not analysts, in the driver’s seat. Says Randi Paikoff Feigin, vice president of investor relations at Juniper Networks, a Sunnyvale, California, provider of networking infrastructure equipment: “Control your own destiny as much as possible.” To that end, Juniper provides guidance to analysts during the conference calls it holds after each of its quarterly earnings reports.
To be sure, some companies can make a better case than others for not issuing earnings estimates. If market or economic conditions are so poor that executives simply can’t predict what a company is going to earn, there’s no sense pretending that they can—and possibly making a bad situation worse. In March, for example, Starwood Hotels & Resorts Worldwide withdrew its first-quarter and full-year earnings estimates, saying it could not gauge the negative impact that the war in Iraq and other economic uncertainties were going to have on its business. “That was a perfectly reasonable position, in my view,” says Louis Thompson, president and CEO of the National Investor Relations Institute. “If you can’t look out any length of time and see how all these external factors might affect your business, and your decision is to not provide guidance, that’s understandable.”
Wall Street may show less sympathy, reasoning that no guidance might mean no earnings or at least lower earnings. Investors were clearly rattled by Starwood’s news. Its stock promptly fell 10%, nearly triple the market’s loss that day, on more than three times its average daily volume.
