The pros and cons of issuing annual guidance

Dec 12, 2016
<p>What guidance is issued now?</p>

The US saw a guidance boom after Congress protected companies from liability for statements about their projected performance via the Private Securities Litigation Reform Act of 1995. 

While no one is required to issue formal financial guidance, a request from your largest shareholder would act as an imperative. On the other hand, three of the largest publicly traded asset managers in the US – BlackRock, T Rowe Price and State Street – do not issue any form of guidance themselves, either annually or quarterly. And while the practice has become common, there are a few high-profile exceptions. 

Alphabet, formerly Google, has famously never issued earnings or any other kind of quantitative guidance while other companies, such as Coca-Cola, stopped issuing guidance but then returned to the practice.

According to the NIRI 2016 survey of best practices in the US, 94 percent of US firms issue financial or non-financial guidance, or both. Most provide only annual guidance, though 89 percent say they would issue updated guidance if there was a material change, and the majority (62 percent) provide guidance in a range. The top five metrics reported are:

1. Revenue or sales
2. Tax rate
3. Capital expenditures
4. Earnings/EPS
5. Operating expenses/margins

The most popular non-financial guidance offered covers market conditions and trend information that could impact the business.

Pros

On the advantages of issuing guidance, Mike Piccinino, a managing director on the medical device and diagnostics team at Westwicke Partners, a healthcare-focused IR capital markets advisory firm in the US, says: ‘There are many advantages to issuing formal financial guidance the most important of which is that financial guidance can be an effective tool for helping the investment community better understand market dynamics, your growth and profitability expectations and the sources of potential headwinds/tailwinds in your business during the fiscal year. 

Sell-side analysts who provide research coverage of your company are expected to publish their forward estimates for Street participants and the group [consensus] averages represent expectations that your performance will be measured against. Guidance from management serves to reduce outlier estimates among the group.’ 

Asked whether issuing guidance is too much like doing the sell side’s job for it, Piccinino adds: ‘It’s a fair stance, but it shouldn’t be a guessing game. In order to maximize the likelihood of earning above-average valuation multiples, management teams should endeavor to help investors and analysts understand their expectations for future growth and profitability.’

Cons

The most obvious disadvantage of issuing guidance on financial metrics is the consequence of missing that guidance, a consequence that might discourage any manager from trying to predict future performance. ‘It certainly draws a line in the sand with respect to where financial results need to come in,’ says Piccinino. ‘Missing the low end of guidance has negative short-term ‒ and longer-term ‒ consequences.’

Other critics have pointed to guidance as a time distraction for management teams ‒ which could be more profitably employed running the business ‒ as well as the short-termist nature of most guidance. Winnie King from Google’s global communications office referenced this in the firm’s recent IPO letter: ‘Although we may discuss long-term trends in our business, we do not plan to give earnings guidance in the traditional sense. We are not able to predict our business within a narrow range for each quarter. 

‘We recognize that our duty is to advance our shareholders’ interests, and we believe artificially creating short-term target numbers serves our shareholders poorly. We would prefer not to be asked to make such prediction, and, if asked, we will respectfully decline. A management team distracted by a series of short-term targets is as pointless as a dieter stepping on a scale every half hour.’ 

For Piccinino, however, guidance doesn’t have to be as time-consuming as it might appear. ‘[Guidance] should be an extension of the hard work in forecasting and budgeting for next year, which the team has already completed as part of the approval process with its board,’ he says. ‘Developing the formal guidance is an incremental step, but the basis for that guidance is already there.’

What to issue?

Piccinino notes that the metrics a company will issue varies dramatically by industry and maturity. ‘For example, a pre-revenue life sciences company may guide on operating expenses or cash burn, while a mature healthcare services company may choose to guide on revenue by division, gross margin, operating expenses and tax rate,’ he explains. 

‘It is important to note that providing guidance doesn’t mean giving every detail. The best approach, in our experience, is to provide the key information analysts and investors need to understand the trends of your business, not necessarily every line of the P&L.’

Sign up to get stories direct to your inbox
logo-black logo-black
Loading