The Issue of Guidance
By Christine Gleim
As a trusted advisor, we are often asked about earnings guidance and whether or not a company should provide it. And if they should, how often and what metrics should be provided.
Unfortunately, there is no one-size-fits-all answer as there are many factors to consider, including the industry and the business model, not to mention the company’s ability to forecast its financials accurately and the demands that doing so can create on management’s time. However, generally speaking, the investment community believes in guidance and a majority of companies do provide some form of financial guidance.
According to a National Investor Relations Institute (NIRI) survey, 94% of public company respondents provide guidance—either financial, non-financial or both—and the number that provide financial guidance has increased 33% since 2007. For the 86% of companies that provide financial guidance, the most common time horizon is an annual estimate, although most indicated that they would issue updated guidance if there was a material change. Finally, the majority of those that guide provide a broad range.
Research has also shown that companies with more predictable earnings, greater sell-side analyst coverage and large market capitalizations are more likely to provide earnings guidance.
Investors tend to think that not giving guidance calls into question management’s ability to manage and forecast the business, but the reality is that sell-side analyst estimates will exist and management will be evaluated on consensus and market expectations, whether or not they help create those expectations.
Providing guidance communicates that a company is confident in its ability to execute on its strategy and that it is transparent with its communications. It establishes a benchmark for comparison to prior results and to a broader peer group and is essential to help buy and sell side analysts build financial models that reasonably reflect a company’s plan. It also leads to decreased likelihood of analyst error and increased likelihood of analyst consensus.
In addition, guidance can help to facilitate institutional ownership and limit stock volatility. If reported financial results are within, or close to, the range of guidance provided then the stock is less likely to react.
And consistently meeting expectations helps build credibility with not only the investment community and shareholders, but also with the company’s customers and partners.
Guidance also creates a framework that enables management to speak openly within Fair Disclosure (Reg. FD) guidelines, which prohibit a company from selectively disclosing material non-public information to analysts, institutional investors and others without concurrently making widespread public disclosure.
The primary argument against guidance is that it drives management to myopic behavior that runs counter to the company’s long-term growth and shareholder value. For example, management might make decisions, such as delaying capital expenditures or other investments that support long-term growth or accelerating a share buyback, to drive earnings.
In 2016, a group of prominent investment and corporate leaders published the Commonsense Corporate Governance Principles, one of which is that “Companies should not feel obligated to provide earnings guidance — and should do so only if they believe that providing such guidance is beneficial to shareholders… if a company does provide earnings guidance, the company should be realistic and avoid inflated projections. Making short-term decisions to beat guidance (or any performance benchmark) is likely to be value destructive in the long run.”
Providing guidance also assumes that earnings should be stable, predictable and feasible to forecast, which is not always the case, particularly for companies with many key variables outside their control.
The consequences of missing guidance, even slightly, can be meaningful in both the short and long-term and can negatively affect the stock price performance, trading volume, short interest position, analyst coverage and the investor base.
There continue to be debates on the value of earnings guidance and there are valid arguments on both sides, but we believe in providing guidance that helps investors understand the underlying drivers of the business.
This can be qualitative and/or quantitative and should highlight the variables that can affect the company’s performance. For example, management could provide an estimated range for revenue and earnings or company-specific factors that affect revenue and earnings, such as same store sales for a retailer, cost per click for an internet company or assets under management for a financial company. Other non-financial guidance might include market conditions and trends and other performance measures, such as the number of customers or growth in key cost categories.
In terms of frequency, we suggest providing annual guidance and updating it quarterly when reporting earnings. Alternatively, for those companies that are unable to comfortably project annually due to a lack of visibility, we recommend providing guidance for the upcoming quarter. The key is that the guidance is achievable.
Ultimately, we believe that the transparency that realistic guidance provides will prove rewarding from the breath of sell-side analyst coverage and quality of the investor base to the stock price performance.
Christine is a Senior Vice President in the Healthy Living Investor Relations group at ICR