Is it possible to predict the quarterly earnings for a business, or a giant multi-billion dollar conglomerate accurately down to a single/narrow cent-per-share figure? A large number of investment analysts out there sure think so! After all, who wants to be the sucker who can only give you a broad earnings range, when “I” can give you the exact figure, so “I” must be better. So pay “me”, and hire “me”! And may god strike it down if that company misses “my” estimate by even one cent! It’s not “my” estimation error, it’s their fault! (Returning back to normal) I’m sorry, I don’t know what came over me just now!
But can you hear the analysts tooting their own horns as they predict earnings? And when did companies think it was a good idea to help these overpaid statisticans along with corporate guidances? Is it a good idea? I’d love to hear from you, but I’ll first share my perpsective!
Why We Should Scrap Earnings Guidances
1. Guidances are for the not-so-competent investors. The serious investors with the know-how would rather rely on their own valuation methods. Earnings guidances are the equivalent of financial fast-food; they’re good to grab on-the-go, without regard and question about how it came to be. What’s in your earnings hot-dog?
2. Stock price A.D.D. Investors cannot pay attention for a long time. Earnings guidances are part of the problem as the market becomes unhealthily pre-occupied with short-term success. We should remember that the market is a voting machine for the short-term, and a weighing machine for the long-term. Earnings guidances are a rally-point for short-term investors who often extremely reward or punish companies that raise or lower their guidances. By the way, who remembers how they felt about earnings guidances 2 years ago for their current holdings?
3. Companies are preceived to have “lied” to us if they missed or lowered earnings guidances. There must be something drastically wrong, right? I want to know how many investors or analysts out there have ever been tasked to run multi-billion dollar businesses? Why do they have the chutzpah to criticize how a business has operated over the last 3 months? Heck, last year we had hurricane Katrina, this year we don’t… what about next year? Likewise, you can’t always predict business conditions. The market prefers to destroy stock prices at the ticker, rather than appreciating that companies are forthcoming with their problems; assuring that they are on top of things. I’d rather judge their actions, their results from those actions, and not their announcements.
4. In a recent Forbes article, Vahan Janjigian wrote that the CFA Institute, the Business Roundtable, the Chamber of Commerce, the National Investor Relations Institute, members of Congress and Securities & Exchange Commission Chairman Christopher Cox have all sounded the alarm bell against companies providing quarterly earnings guidance to Wall Street and shareholders. But Vahan would rather focus on a study done by the National Investor Relations Institute about earnings guidances. The study does fit Vahan’s sentiments on the subject matter written years ago.
Now, I’ll admit… besides the members of Congress who possess the sophistication of comparing internet to tubes, that’s still a pretty diverse, distinguished group advocating for the abolishment of corporate guidances! My problem with “studies” is that there are so many opportunities to study the wrong thing! For example, the article cited Krispy Kreme as a “great” example of how removing corporate guidances did not help. My argument is that corporate guidances are the reason that led to the implosion of Krispy Kreme in the first place… which leads to our next point.
5. Corporate Malfeasance. At some point in their career, CFOs and CEOs forget that they were hired to run the business and start auditioning for a full-time career in PR, stock manipulation and damage control. They sign extravagant contracts to be used as exit strategies. The obsession with pleasing the stock market, the hand that feeds them, eventually leads to promising outrageous numbers. If they can’t make those numbers, they’ll inflate what they have. But you see, the market getting an inch now wants a yard! CFOs have to keep up the charade, and keep cooking the books. If you are the type that wants to take advantage of such situations, perhaps this can also be a reason FOR earnings guidances. You might be interested with my book club challenge on short selling? But I’m just trying to look out for the average joes.
6. I’ll take one last stab at Vahan’s Forbes article (from point #4). The study looked at 76 companies from 2000 through 2004. Wow, that’s a big sample size and a long time frame! My second problem with studies is their variables – what is truly representative? Ask somebody in south-east Asia about the merits of spaghetti sauce and I’m not sure how representative your data can be. The number of companies that give guidances far outstrip those who don’t. I’m sure someone can easily find 55 (not even the same number!) out of the thousands giving guidances to be used as great counter-examples.
Vahan asserts that not releasing guidances has destroyed shareholder wealth while I suggest that it’s the “stopping” of guidances that has invited backlash. What happens when you cut off a drug addict cold turkey? The bigger issue was whether the confidence to put all that money into those same stocks was justified in the first place? That confidence and irrational exuberance is mostly due to previous “favorable” guidances! It’s hard to end a vicious cycle. Maybe that’s why God had to flood the earth and only spared Noah’s Ark.
Why We Should Keep Earnings Guidances
1. Transparency. Why shouldn’t CFOs provide as much information as possible, including quarterly and annual business projections? Isn’t this to the interest of better information for investors? Isn’t this part of the “perfect information” that markets (as opposed to individual investors) are often assumed to possess? [Oops, I’ll play devil’s advocate here again! Information are already disclosed through regulatory SEC filings. Whether they are perfect is debatable. But summarizing it with a range or a single number doesn’t give more information, or make it perfect. Guidances are merely a lazy, convenient “big-picture” method to making a decision. See my fast-food example above.]
2. Guidances assure the investors that CFOs have put some thought and work into it, and know what is going on with their business through quarterly reviews. If you hold down a job, I’m sure you’d appreciate if your manager sat down to review your performance quarterly, too bad they don’t often reveal the “number” you should be getting next quarter. But this process allows CFOs to examine controls and processes so that the ship does not veer too far off course.
3. Stock price A.D.D. Why is this a reason to both scrap AND keep guidances? Truthfully, I’m torn on this subject. I believe that the correct temperament towards earnings announcements gives me the edge I need to beat the herd. Over-reactions to guidance hits and misses provide for great opportunities to transfer wealth from the emotional market to the logical, rational crowd. It sounds morbid and exploitative but it’s a valid point when everybody is investing to make money, isn’t it?
Where Do You Stand?
You might be able to guess where I stand on this issue. But I’m by no means right. I have my opinions and you have to go by what you’ll decide. I would love to hear your views on it. Nobody has all the right answers, but if we compiled enough perspectives and take an objective view of the information, we can make a better educated decision.