Earnings Guidance – You Can’t Ignore It

In the feature article, David Perry, VEM’s Director of Research and a former broking analyst (and lecturer on the sharemarket) looks at the background to the debate surrounding guidance, and VEM’s top 10 rules to consider prior to and when providing guidance.

Why earnings guidance is a growing trend that you can’t ignore

The most recent US survey by the IR umbrella organisation, NIRI, (released in March 2005) estimated that just over 70% of the top 500 companies provided some form of earnings guidance. An Australian survey by AIRA, released in May 2005, noted that the majority of its members who responded (top 200 companies) “give the market some form of guidance about future performance”.

The different types of earnings guidance provided by Australian companies include profit and EPS growth ranges or specific targets (eg SGB, ANZ, SMS), sales and profits (WOW), profit margins (QBE), and revenue and margin targets/ranges (TWO). Other companies may eschew explicit guidance but make a comment when an organisation’s internal forecasts are outside market consensus (eg CBA) or simply confirm that its estimates are consistent with market consensus. Some companies back this up by including broker or market consensus forecasts on their website. (eg AMC). A handful of companies also provide quarterly updates on sales (eg CML, WOW) and/or profits (eg SMS, BKL) or provide other performance statistics on a quarterly or monthly basis (eg AXA and PPT).

A number of factors that have contributed to increasing use of earnings guidance by public companies but two of them stand out as key drivers:

1. Communications technology has improved the speed and reduced the cost of getting information to the market, not only creating opportunities for companies to have a more open dialogue with shareholders but also forcing them to ensure the right information is in the public domain.
2. An increasing focus on corporate governance and regulatory changes including increased emphasis on continuous disclosure, industry standards on communications between companies and analysts (eg one-on-one meetings), and increased penalties for breaches of the law.

These developments have meant that there is much greater pressure on companies to make public disclosures and avoid selective disclosures. The days of delivering messages of optimism to the industry via individual analysts are over. ASIC/ASX guidelines now specify that companies comment only on facts, not forecasts.

To guide or not to guide … that is the question.

So, clearly, there’s some pressure in the background to think about earnings guidance, but it’s not compulsory. So why do companies do it?

• For large companies, there’s enormous pressure from analysts. An analyst’s key focus is on forecasts - making detailed estimates of profits and cash-flow, in particular, and valuing the company based on these. Companies are under ongoing pressure to fill in the pieces of the forecast puzzle.
• There can be scepticism about the roles of brokers and many companies take the view that they’d rather have their own forecasts in the market than just those of the analysts.
• And, finally for smaller companies in particular, it has become harder to secure analyst coverage. One way of encouraging brokers and investment community to follow a company is for a company to make public forecasts. This reduces the cost and risks of information gathering and, potentially, the cost of capital.

What about companies that choose not to issue guidance? What are their reasons?

• The companies may feel that the analysts are already doing a reasonable job and they’re happy to be in the hands of the market.
• Forecasting can be very difficult and often companies are worried about the increased risk and potential legal liability if the forecasts are not achieved.
• Sometimes it’s just too tough to call. There are many businesses, such as those subject to climatic or commodity market fluctuations, where they feel the uncertainty and volatility is simply too great to allow them to offer reasonable forecasts.