Companies face earnings guidance dilemma

Companies providing earnings guidance face a range of potential problems.Consequently some, such as Coca-Cola, have given up altogether

The volatile markets of 2004 have left CFOs and sell-side analysts at opposite ends of a high-wire balancing act. When analysts push for more ‘acceptable’ earnings estimates, CFOs worry more about meeting the Street’s targets than taking care of business – so the estimates tail wags the equity dog. And once the CFO spins the data to meet expectations, the Street’s credibility is threatened.

Faced with these risks, it’s not surprising some corporations are choosing to abandon earnings guidance. While not yet a full-blown trend – 76 percent of companies are still providing earnings guidance, according to a National Investor Relations Institute (Niri) survey from June 2004 – more companies than ever are looking at the guidance issue.

Among companies not providing guidance, the thought leader is Coca-Cola. In September 2004, with a newly appointed CEO in place, the company veered away from its policy by issuing a guidance statement following the addition of a new ingredient to its famous formula; the statement spelled out the business trends affecting the company’s performance.At this point, it’s unclear whether Coke’s ‘don’t ask/don’t tell’ guidance policy has lost its fizz. However, among IROs, there is certainly a sense that when the consensus estimates are out of line, companies need to be proactive in outlining the factors affecting performance.

The foundation of IR is the realization that public companies cannot operate in even the best-capitalized vacuum. Many companies that refuse to give out hard numbers still recognize the valuable role played by analysts and realize they need to give them something to chew on. So while it’s clearly justifiable to pull guidance entirely off the table if either business conditions or internal forecasting issues make accurate guidance impossible, it’s crucial to recognize the role guidance can play. For instance, according to one portfolio manager, the buy side views the guidance companies provide as having a 90 percent probability rate. That’s pretty high.

Naturally, the buy side’s biggest concern is quality of information, not frequency. In a recent perception study for a mid-cap high-flying technology company that doesn’t provide guidance, nearly all investors said they felt the company’s qualitative updates on trends impacting the business were enough to help them forecast effectively. But during times of uncertainty, analysts and investors insist on more guidance. The irony is that this is precisely when companies tend to clam up.

You may choose to do what Coke is doing by making an exception to your policy. You might also do what others have done and provide a timeline for the factors that will signal a return to more normalized business conditions and explain why providing quantitative guidance is a fruitless exercise. If you take either of these approaches, though, expect fallout from short-term investors.

If you do decide to provide regular guidance, there are specific issues you have to work out long before the numbers hit the Street. Firstly, look at the predictability of your industry and business. Next, measure your ability to provide accurate, on-target guidance: your management has to be comfortable with the guidance you’re presenting. It’s also crucial to look at the availability of market and company information outside of earnings guidance as well as analyzing the level of detail you’re providing to the Street – and the competition. Lastly, remember the purpose of this process is to keep analysts’ expectations reasonable.

As we have seen, there are valid arguments on either side of the Street both for and against providing earnings guidance. My personal view is shaped by a rather pragmatic consideration: companies that provide guidance that isn’t met are penalized more over the long term than companies that choose not to provide guidance at all. Companies with less predictable revenue and earnings streams should, therefore, provide less guidance. For many this means a move to annual guidance, not quarterly. And companies with limited guidance should spend more time educating investors that are willing to buy the stock without guidance, and less time with those that aren’t.


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