Just about everyone in the business world is having a tough time predicting what the future will bring. Never mind the hazy, distant future, even next week’s sales are a mystery. Add all the divisional question marks together and the top line gets awful blurry; forecasting revenues for the quarter is next to impossible. Plus, the crackdown on accounting irregularities has put an end to tweaking the bottom line to meet earnings expectations.
From micro to macro, from the lousy economy to war in the Gulf, from consumer sentiment to Sars, the forces have been adding up to make future financial results nearly impossible to predict. Many quarterly earnings releases now include a pat phrase saying, ‘Due to uncertain visibility in the marketplace we are unable to predict beyond the current quarter.’
Trouble is, the last bull market, which still dominates the investor psyche like a three-year hangover, created an insatiable appetite for earnings-per-share news. In the 1990s many US companies responded by releasing mid-quarter EPS updates. Consensus estimates were leading indicators of stock performance, and the number one job of IR was ‘earnings guidance’ – delicately nudging analysts up or down in their estimates.
‘Companies were all trying to attract more analyst coverage and tried to present a good story by saying, Our earnings will be up 29 percent. But if they didn’t deliver they were in real trouble,’ recalls Chuck Hill, director of research for First Call.
Today, lack of visibility makes it difficult to give clear earnings guidance, but the culture is still one of short-term results. The media, the sell side and some buy-side investors are trained to watch earnings estimates on First Call or Multex. The earnings consensus is the magic hit-or-miss number used to gauge a company’s near-term financial success. It also motivates buy and sell decisions to the point that missing the consensus number by a mere penny could result in dramatic stock price movements. How to deal with the influence of earnings consensus numbers and the demand for earnings-per-share news when the results are near-to-impossible to predict or meet is the conundrum companies now face.
Luckily for Europe and Asia, most investors there never caught the earnings estimate bug, not least because quarterly reporting is still uncommon outside of North America. Forecasting and guidance on future EPS are also rare. Indeed, under Hong Kong’s current rules, ‘Earnings projections are prohibited unless accompanied by an independent accountant’s report,’ notes David Webb, a Hong Kong-based governance activist and editor of Webb-site.com. Webb says some companies get around the ban on forecasting by ‘whispering to analysts’ about earnings expectations.
In Europe, guidance is often limited to a trend statement included in annual reports that informs on uncertainties that could affect future growth but doesn’t promise concrete results. That may change now that the European Commission is proposing mandatory quarterly reporting and more detailed half-year reports. But the debate is fierce, with companies and investors alike arguing that quarterly reports will increase volatility as well as costs.
Nevertheless, quarterly reporting is slowly spreading. It’s already mandatory in Malaysia, Singapore and mainland China, and it’s required for companies on Hong Kong’s Growth Enterprise Market. Hong Kong’s main board pulled back from such a move so only a few large companies report more often than twice a year.
Even if more Asian and European companies move to more frequent reporting, it’s unlikely they would give quarterly EPS guidance – even if there was more certainty about business cycles. Besides, earnings guidance is now a hotly contested issue in the US. Some say it’s necessary in order to steer analysts to the right consensus number; others argue earnings guidance leads investors and analysts to focus on the short rather than the long term.
Stopping guidance
Two years ago, Gillette decided to stop giving earnings guidance. More recently, a prolonged period of poor visibility has inspired several other brand name companies – Coca-Cola, McDonald’s and AT&T – to announce the discontinuation of annual and quarterly earnings-per-share guidance as well. Others acknowledge the haziness of crystal ball gazing but still give mid-quarter updates, often announcing the company will miss its earnings-per-share target for the current quarter. Either way, IR professionals are living a nightmare populated by investors and analysts desperate for near-term forecasts in a market filled with uncertainty.
In fact, the companies that have so far stopped giving guidance report positive feedback from the buy side and little backlash from the sell side. Take Coca-Cola, for instance, which rocked the IR world in December 2002 with the announcement that it would no longer provide earnings guidance.
‘Our senior leadership team established the policy of not providing quarterly or annual earnings guidance following a series of discussions with our board of directors over the past year,’ reports Denise Hendrix, IR manager at Coke. Some sell-side analysts were disappointed they were not going to be getting clear guidance but others saw it as an opportunity to add more value to their research, Hendrix says: ‘Most of the buy side have expressed to us that they are pleased with our decision.’
The longer-term impact of Coke’s decision is hard to assess after just one quarter. As soon as it ended guidance, some analysts speculated its earnings consensus would be off. But, Hendrix says, ‘We haven’t seen any real changes to the sell-side research.’
Sun Microsystems recently decided to stop putting out mid-quarter EPS updates because the lack of market visibility precluded useful guidance. ‘We had been doing a mid-quarter update for the last couple of years but found that we really weren’t clarifying that much,’ says Jeffrey Boldt, head of IR at Sun Microsystems. ‘We didn’t have good clarity for any given quarter and the information we were giving proved to be different at the end of the quarter.’
‘We felt we would be better served by getting out there and talking to folks about things we did know about like our strategy going forward in the marketplace rather than spending a lot of energy and not providing a lot of information,’ Boldt adds.
As with Coke, the buy side supported Sun’s move. ‘They said they understood and were in it for the long term,’ Boldt reports. ‘The sell side saw it more as a take-away of information but the reality was we weren’t providing a lot of value [in the update].’ Sun was just one of a handful of tech companies with regular mid-quarter updates, so its decision to stop brought it in line with the industry standard.
Guidance still the norm
Just because stopping EPS guidance seems to be working for Sun and Coke doesn’t mean that lesser-known companies should follow their lead. ‘Coke may have the ability to do it, but small-cap companies might feel they need to provide guidance in terms of what is going to happen because they will lose sell-side coverage otherwise,’ says Lou Thompson, president and CEO of the National Investor Relations Institute.
‘Small-cap companies spend their whole time looking for coverage and to get three or four sell-side firms to cover them is a victory,’ agrees Edward Curtin, senior vice president of corporate business development at Fair Disclosure Financial Network (FDfn). ‘If they make it more difficult for the sell side to cover them versus their peers [by stopping giving earnings guidance], they may lose coverage.’
Despite those well publicized decisions to stop giving earnings guidance, most US companies still do it. A recent Niri study shows 78 percent of companies giving some kind of guidance. Of those, 11 percent give point estimates, 8 percent give their earnings model, around 62 percent give revenue guidance and a whopping 75 percent give EPS guidance in a range.
Not only are the majority of US companies still providing guidance, an analysis of press releases by PR Newswire shows a significant increase in the number of earnings projection, forecast and guidance releases sent out by companies in early 2003 – a 21 percent increase in January compared to a year earlier, with February showing a 29 percent jump since last year.
This suggests that more companies are giving guidance and they are doing it later in the quarter. ‘The fact that you are seeing a 29 percent increase in February [over last year] shows that companies are doing the update after they have solid information,’ says David Armon, president of PR Newswire Americas. ‘There are at least 1,100 fewer publicly-traded companies in 2003 versus 2002, so it’s a smaller pie but a larger volume of earnings projections among the remaining companies.’
More with less
When Coke et al announced the end of annual and quarterly guidance, critics said they were robbing the investment community of critical information. There was a perception that they were providing less information at a time when investors and regulators were demanding more. But the critics may be proven wrong.
‘The notion that companies that stop giving guidance don’t give enough information is false,’ says Thompson. ‘Those that have stopped are still providing other kinds of information like trend information, industry information, and qualitative information about market conditions, business measures and other things that drive the business.’
Coke’s Hendrix says that when the company issued its earnings release in February 2003, ‘We received compliments on our disclosure of more historical information. This helped to alleviate the fears of some who were afraid no guidance would mean less information.’
Progressive Corp is one example of a company that doesn’t provide earnings guidance but still offers good disclosure. ‘As far as we know we’re the only publicly-traded company that publishes monthly operating information,’ says Tom King, head of IR. ‘We understood the pressure on companies to meet earnings projections but were never comfortable providing focused earnings guidance. We now release information twelve times a year instead of four. Investors can update their projections more frequently and it’s very difficult to get surprised if you are getting results every month.’
King says the reaction from both the buy side and sell side has been favorable. ‘The volume of phone calls has dropped,’ he says. The IR policy on Progressive’s web site makes it clear the company doesn’t share earnings projections or provide focused guidance. ‘We have an obligation to give investors enough information to make reasoned decisions about our securities but none of us knows what the future holds,’ says King. ‘We can give you what management uses to make decisions when we compile information monthly.’
Bad visibility can mean volatility when a company misses its EPS. The inability to predict market behavior and the effect of volatility on the stock were good reasons for Progressive to adopt monthly reporting. Since it started this in May 2001, volatility has dropped dramatically. As King says, ‘Since we started reporting monthly, the effect on volatility was like a dose of tranquilizers.’
In the UK, some investors are calling for more ad hoc disclosure, meaning no closed period for when a company reports. In other words, when something material happens, it should be immediately made public, which could definitely lead to monthly reporting or for a more instantaneous effect, continuous online reporting.
From King’s perspective, there are real advantages to reporting monthly, including fewer questions from analysts and investors, dampened volatility and a favorable effect in terms of meeting the earnings consensus number. Critics of the ad hoc approach in the UK think it will train the investment community to focus on short-term results, as the quarterly earnings game has done in the US. However, the key distinction between monthly reporting and earnings guidance is the former reports historical information while guidance attempts to forecast the future.
No crystal ball
Forecasting the future – rather than quibbling over when or how companies report – is the real issue today. Crystal ball gazing is not something anyone, whether analyst or market guru, is capable of right now. No-one can pretend to know what will happen over the next week let alone the next quarter. As a result, IR professionals are being pressured to change the way they communicate with the Street, whether it’s dumping earnings guidance or focusing more on what they know rather than what they can guess.
‘We are considering stopping EPS guidance. But we started to give guidance for 2003 so we feel we have an obligation to continue,’ says Kevin O’Brien, vice president of IR at Nationwide Financial Services. ‘It’s getting harder and harder [to give guidance] as things become more uncertain.’
O’Brien is dealing with the dearth of visibility by talking more about areas the company can influence and control and by trying to get analysts and investors to focus less on the next 30 or 90 days. ‘We have a fair amount of our earnings exposed to the equity markets so our approach has been to keep our heads down and focus on our business model. It’s not that we are ignoring the market but we are trying to keep it in perspective.’
Rather than predict what will happen in the market and how it will impact future results, O’Brien is talking about how the company is getting through the market lull and how the insurance business in particular is being affected. ‘The decline in equity markets could make insurance companies take some charges around different acquisition costs and there are other things that put pressure on your balance sheet,’ he says. ‘We are spending a lot of time talking about our capital position; if the market continues to slide we will be out raising capital.’
Buy-side investors following the insurance sector are less focused on short-term results and more focused on the balance sheet and income statement right now, notes O’Brien: ‘They are looking at whether you will survive this [market downturn] rather than what the next quarter’s earnings will be.’
Looking for benchmarks
While it’s very difficult to give investors precise benchmarks to watch over the next few quarters as a guide to monitoring a company’s results, it’s important to outline the general influences and how they will affect the stock.
‘The most important thing is to give investors all the nuances on what is going well and what is not going well and then what effects those things,’ suggests Alice McGuire, former head of IR at Compaq. ‘There is obviously uncertainty over the war and potential terrorist attacks. Consumers have stepped back from the economy for now – those things are pretty evident to investors but it’s still important to explain how they’re affecting your stock.’
‘Being candid is really important,’ notes Ken Janke Sr, chairman of the National Association of Investors Corporation (NAIC). ‘Don’t be an ostrich when the economy turns south; continue to supply information whether you give guidance or not.’
‘It is impossible to see where the market is going to go but there are many controllable factors for a company. And if you are agile, you probably brought down costs once revenues slowed,’ adds McGuire. Informing investors about long-term contracts with customers and suppliers helps them understand how you are positioned to deal with this uncertain economy, she adds. ‘Help them understand what you have leverage on and what you don’t; and give them the insight into what you can control other than the economy.’ In short, inform investors about ‘what you can manage from where you are sitting.’
Conflicting views
First Call’s Chuck Hill doesn’t think IROs should stop giving earnings guidance. ‘You’ve got to give analysts some help. Give them a top line number in a range and an idea of what you think you’re going to do, like we think earnings will be up 10-15 percent next year.
‘In addition you have to give analysts some kind of idea how you are going to run the business under different scenarios,’ Hill adds. ‘The analyst doesn’t know whether you’re going to hold R&D constant no matter how much sales are going to be up, or what you’re going to do – so you need to give some kind of sense.’
Alice McGuire, former IRO for Compaq, agrees that ceasing earnings guidance can send the wrong message to the Street. At Compaq, she says, ‘we talked about stopping earnings guidance around the time FD was implemented. We had just replaced our CEO and CFO, so there was this huge turmoil of trying to reconstruct credibility. My conclusion was that to stop giving guidance would have been the same as saying, We don’t know.’ McGuire continues, ‘We decided to give reasonable guidance in a range, and we had an understanding with management that if we were going to fall outside that range we would give new guidance.’
Lou Thompson, president and CEO of Niri, thinks the problem is less the lack of earnings guidance, more the influence the consensus number put out by First Call has on the market. ‘The consensus is not a consensus [number] and I don’t know why investors treat it as a magic number,’ he says. ‘First Call is publishing a range but everyone is still focused on the number,’ adds Thompson. Also, analysts’ estimates are compiled on a pro-forma basis so companies that report solely in Gaap find their consensus number is higher than they are reporting. According to Thompson, the underlying assumption with the consensus is that companies can manage their earnings through the accounting process, which is taboo given the current focus on proper accounting.
