Guidance (not so much Earnings) in Focus

John Boardman

At the beginning of each calendar quarter, the market conversation uniformly switches to earnings.  Each trading day, for a several-week period, publicly traded companies report their earnings for the previous quarter.  The two main “headline numbers” are revenue and earnings per share.  For a multitude of reasons, this quarter feels a bit different; the markets are most curious about what these companies are reporting for the coming year, not how they finished 2018.

Earnings guidance is just what it sounds like.  Companies who choose to report guidance (we’ll touch on that in a moment) will provide an estimate of the next quarter and often the next fiscal year.  For companies that provide guidance, the primary thought is that complete transparency will avoid earnings surprises and, in the best of times, provide a boost or support to the stock price.  With so many questions floating around the markets related to economic strength of the US and global economies, the markets are already showing a heightened interest in those companies providing guidance.  On January 2nd, Apple preemptively provided guidance for the next quarter.  In a slightly unusual move, this report (via a letter from CEO Tim Cook) was released four weeks before Apple is set to report.  Much of the letter dealt with the company’s belief that the Chinese consumer is showing unexpected signs of weakness.  Interestingly, the stock sold off and has been a relatively weak performer since the letter was published.  Some people might argue that there were political motivations at play in this release (i.e. trade and tariff issues).  You could also argue that Apple knew its numbers were going to be weak and did so in an effort to “soften the blow” when earnings are eventually released.  Both issues were likely contributing factors and it is impossible to know the exact motivation. However, this begs a much larger question; does releasing forward guidance have an impact on how a stock performs?

In 2006, McKinsey and Company conducted a study¹ assessing this very question and the conclusion was made that there was no discernible difference in stock performance in those companies who decided to issue forward guidance.  In fact, there is a strong argument to be made that issuing forward guidance is a thankless and expensive use of company resources.  The authors of the McKinsey study concluded, “The voluntary disclosure of financial information is a key component of high- functioning capital markets. The current trend—more and more companies discontinuing quarterly guidance and substituting thoughtful disclosures about their long-range strategy and business fundamentals—is a healthy one. In this way, companies will better signal their commitment to creating long-term, sustainable shareholder value and encourage their investors to adopt a similar outlook.”  There has been a marked increase in the number of companies that have determined this to be the case, essentially announcing they will no longer issue forward earnings guidance.

As earnings roll in over the coming days and weeks, we would expect individual stock names to react based on any guidance released.  Specifically, companies with direct exposure to consumer spending will be closely watched by analysts trying to assess the strength of consumers, both domestically and internationally.  With the Federal Reserve in the process of trying to normalize interest rates, ongoing trade talks between the US and China, and the government shutdown not having an end in sight, everyone is interested in how much momentum still exists in this economy.  Rather than listen to politicians or even the Fed tell us how things are going, there is no better way than to actually hear from those companies on the frontlines of consumer activity.

Source:

  1. McKinsey and Company. “The Misguided Practice of Earnings Guidance.” By Peggy Hsieh, Timothy Koller, and S. R. Rajan.  March 2006.
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