The morning blog published by the CFO Journal of The Wall Street Journal last week opened with a mention of Alex Edmans, Professor of Finance at London Business School, and his advice to companies on Five Ways CFOs Can Focus on the Long Term. One of the ways Edmans described is to avoid providing earnings guidance, which is quoted below.
“Avoid Providing Earnings Guidance. Providing guidance on likely quarterly earnings numbers increases transparency, but also means that the market holds firms accountable to their forecasts. Thus, companies will focus on meeting short-term targets, rather than pursuing long-term value,” Alex Edmans.
Promoting a short-term view by providing earnings guidance is an unintended consequence of the Fair Disclosure Act of 2000, in my opinion. I also believe we have come a long way in the last fifteen years under the watchful eye of FD. Many corporations have learned how to provide guidance while building long-term value.
In the old days we would manage expectations to a tight range of sell side EPS estimates by reviewing and commenting on the brokerage analysts’ financial models. We did not provide actual dollars or percentages, but would try to correct any misperceptions about operations leading to inaccurate financial expectations reflected in the models. Most portfolio managers relied on a combination of their own internal financial models and sell side research to make their investment decisions to buy and sell stock.
As FD was changing conversations between corporations and institutional investors, the number of brokerage firms was starting to decline as a result of industry consolidation and a new type of hedge fund investing was just beginning to grow. Not only were conversations changing, the market was changing. Providing guidance to manage sales and earning expectations leveled the playing field and many long-term institutional investors complained that the practice eliminated the competitiveness of stock picking. It seemed to be helping the less analytical, short-term investor.
In 2006 the CFA Centre for Financial Market Integrity published Breaking the Short-Term Cycle comprised of a discussion and recommendations on how corporate leaders, asset managers, investors, and analysts can refocus on long-term value. Concerning earnings guidance only, the panel encouraged:
- Ending the practice of providing quarterly earnings guidance.
- However, companies with strategic needs for providing earnings guidance should adopt guidance practices that incorporate a consistent format, range estimates, and appropriate metrics that reflect overall long-term goals and strategy.
- Support corporate transitions to higher-quality, long-term, fundamental guidance practices, which will also allow highly skilled analysts to differentiate themselves and the value they provide for their clients.
At the time, I was the IRO for a nearly $3.0 billion market cap retailer with a growing PBM business managing through a turn around. We had provided quarterly and annual revenues and earnings guidance since the beginning of the turnaround primarily due to the unpredictability of our retail operating performance and financial results. We consistently provided a nickel spread for quarterly earnings per share and a dime for the spread for annual EPS, which was revised quarterly. Rather than labeling this information guidance, we were more comfortable calling it Management’s Outlook.
The following was extracted from one of our earnings releases and included in the earnings conference call script.
For the quarter ending date, Company Z estimates total revenues will be flat to negative 0 percent and same-store-sales will be flat to up 0 percent compared with last year. Given these revenue assumptions and the Company’s continued progress on previously stated initiatives, Company Z’s goal is to achieve net income of $0.00 to $0.00 per diluted share in the first quarter. By comparison, Company Z reported net income of $0.00 per diluted share for the first quarter last year.
For the year ending date, Company Z estimates total revenues will increase 0 to 0 percent and same-store-sales will increase 0 to 0 percent compared with last year. Given these revenue assumptions and the Company’s continued progress on previously stated initiatives, Company Z’s goal is to achieve net income of $0.00 to $0.00 per diluted share this year compared with net income of $0.00 per diluted share reported last year.
In addition to the top and bottom line, we provided relevant financial and non-financial metrics to better link operating performance with future financial results. Examples include:
- Future shifts in holidays or the fiscal calendar which would impact revenues for a given quarter or full year
- New initiatives and progress updates on existing initiatives
- Range of expected one time costs or charges for future quarter
- Effective tax rate for the year
- Range of increases in inventory for future quarter(s) when significant
- Range of depreciation and amortization expenses for the year with updates when necessary
- Range of estimates on capital spending for the year with updates when necessary
- Expansion and remodeling plans for the year
- Future regulatory changes that could impact financial performance
- Long term (5-year) growth rate for number of stores
- Long term goal to achieve operating margins comparable to our peer group
By 2007, our operations were improving and our financial results were becoming more predictable. We started evaluating our practice of providing Management’s Outlook on revenues and earnings. I still have the presentation to my then Board of Directors recommending we eliminate the practice of providing Management’s Outlook over a three-year period. We were not pioneers in this quest as many corporations were evaluating their guidance practices at the time as well.
Apparently, we have gone full circle. The National Investor Relations Institute (NIRI), conducts a study of guidance practices every other year. Providing guidance remains popular; however, there has been a shift away from quarterly guidance.
According to the 2014 NIRI Guidance Practices Survey, approximately 94 percent of the companies responding to the survey provide some form of guidance including financial and non-financial. This compared with 78 percent of the companies responding to a similar survey in 2003.
According to the 2014 Survey, the majority of companies providing guidance choose do so on an annual time span (85%), which is nearly flipped with the data collected in 2003. The 2003 Survey indicated a majority of the respondents providing guidance chose a quarterly time span (52% quarterly; 25% both quarterly and annually; and 15% annual only).
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