Earnings guidance isn’t what it used to be. But then, you knew that. A recent study by the National Investor Relations Institute (Niri) of 527 IROs shows a distinct trend toward longer-term perspectives in giving guidance. Moreover, the number of firms willing to give guidance fell to 71 percent from 77 percent in 2003.
The topic has long been the target of criticism. Some say it skews the focus of senior management by homing in on near-term results. In the worst case scenario, management can lead itself down a very slippery slope to outright fraud.
Warren Buffett, CEO of Berkshire Hathaway, famously outlined the problem in 2002, the same year that Coca-Cola, where he is a board member, decided not to issue guidance anymore. In his annual letter to shareholders, he wrote: ‘It is both deceptive and dangerous for CEOs to predict growth rates for their companies. They are, of course, frequently egged on to do so by both analysts and their own investor relations departments. They should resist, however, because too often these predictions lead to trouble.’
Those who favor not providing guidance say it actually improves Wall Street research by making analysts work harder on the numbers to make their predictions. Chuck Hill, CEO of Veritas et Lux and former head of Thomson Financial’s FirstCall, doesn’t advocate banning guidance but thinks companies need to make analysts work harder. ‘Too much spoon-feeding by IR has turned analysts into highly paid stenographers,’ he said at a recent IR magazine think tank in New York.
Wiggle room
Still, smaller companies, already struggling for visibility among investors, need every tool they can muster. Many of these companies don’t have analyst coverage and there is a sense that providing guidance will likely help attract sell-side notice. Just over a third of the IROs surveyed by Niri say they would lose some analyst coverage if they stopped issuing guidance – and around 70 percent of the companies surveyed by Niri fall into the small to mid-cap range.
So it makes sense that, failing a desire to stop giving guidance altogether, the best alternative is to get more wiggle room. According to the Niri survey, there has been a steep increase in the number of companies providing annualized guidance – from 38 percent in 2003 to 61 percent today. Meanwhile, the number of companies that also provide quarterly guidance has slipped from 75 percent in 2003 to 61 percent now. Companies that provide only quarterly figures also went down to 28 percent from a previous 53 percent. And there was a major increase in those that provide annual guidance only, up to 28 percent from 16 percent.
By moving to annualized guidance and ranges rather than specific price points, companies allow themselves latitude in their final performance. Having to hit a target only once a year as opposed to quarterly adds further breathing space.
Tug of war
The Niri data also shows that more IR departments are considering dropping EPS numbers altogether. In 2003, 78 percent of the 527 Niri members surveyed were not considering dropping EPS guidance – that figure is down to 64 percent in 2004. But when asked whether giving up earnings guidance would help analysts develop a long-term view of the company’s financials, 50 percent of respondents said ‘no’.
The furor over EPS really started post-Regulation FD, which was implemented in the fall of 2000. ‘It used to be that a chief financial officer or CEO was fairly quick to give some indication of how the next few quarters would turn out when talking with larger holders,’ says John McConville, a former Bear Stearns analyst now with Shore Communications. ‘Those days disappeared with Reg FD. Now it is all about what the corporate attorney is telling the executives to do.’
A veteran of executive suite disclosure battles, Jim Morakis, president of Morakis Associates in New York and a former spokesperson for ExxonMobil, notes that for bigger companies the legal dominance of disclosure practice predates Reg FD. ‘If a professional communicator is standing in the room with the CEO and the chief counsel and they disagree on a course of action, there is no question the boss will go with the guy who could keep him out of jail,’ Morakis says.
But analysts want guidance and, especially for small caps, giving them what they want may be the only way to keep or even attract their attention. ‘Both the buy side and the sell side welcome guidance; any is better than none,’ says McConville.
Chill factor
Another finding of the Niri survey is that the number of companies updating their earnings guidance to reflect a material change is up from 80 percent in 2003 to 93 percent. But affirming or changing guidance is now cause for concern and confusion following the Reg FD case against Flowserve in March.
Texas-based Flowserve, a leading producer of pumps and valves, settled with the SEC without admitting any wrongdoing and paid a fine, as did its CEO Scott Greer, who subsequently stepped down. Greer and Flowserve’s IR director, Michael Conley, were charged with selective disclosure. The SEC said management gave out specific guidance to a group of analysts without informing the investment public at large. According to the commission, this action violated Reg FD and the company’s disclosure policy.
While Conley was apparently in the room when the CEO spoke, he was not forced to pay a fine. Nevertheless, the SEC focused on his role in saying he failed to caution Greer during a meeting with a group of analysts. ‘In fact, Conley remained altogether silent,’ according to an SEC press release. Conley declined to comment on the case.
The Flowserve case is forcing companies to consider how far into the reporting period they can reaffirm, in a non-public meeting, previously released earnings guidance without it constituting a violation of Reg FD. At the recent IR magazine think tank in New York, attendees expressed confusion over what constitutes the best disclosure policy. Many feel their hands are tied when it comes to guidance – and are clearly worried about their own liability.
‘Meaningful guidance is a necessary tool for analysts to make meaningful estimates,’ commented one attendee, while others are considering giving up EPS guidance altogether. Some IROs say guidance is immovable, while for others it’s just the opposite. ‘Guidance you put out is the guidance until something changes, and everyone should then be informed,’ noted one IRO.
The tipping point
It is hard to know just how widespread the practice of issuing guidance is. The Niri survey shows trends among just 527 members, and the association has around 4,300 members. Moreover, the Niri membership represents an elite grouping inclined to be more in tune with what works best in the marketplace. Indeed, Niri urges its members to offer guidance as part of best practice. It says regular guidance helps dampen stock volatility.
But adding to the question of how far guidance reaches into the market is the fact that Niri’s membership itself is a relatively small percentage of the nearly 15,000 publicly traded companies in the US, according to Moody’s Investor Service figures. Add to that a global list of a further 20,000-plus companies and the entire matter starts to look more academic than the high-profile company actions and their media coverage would lead investors to believe.
In 2001 Gillette decided to stop giving earnings guidance and then in 2002 other highly visible companies – including AT&T, Coca-Cola and McDonald’s – announced their decision to discontinue annual and quarterly earnings-per-share guidance. More recently, Coca-Cola, with a new CEO at the helm, diverged from its no guidance policy and gave quarterly EPS figures to the Street, causing some to wonder whether it is indeed possible to avoid guidance altogether. IROs are at the center of this debate because they’re faced with tempering the analysts’ appetites and management’s desire to control the disclosure of financial information.
If one thing is certain, it’s that this debate will continue. Analysts will insist they need the direction while corporations will struggle to satisfy their own desire and inclination to avoid missing expectations and having the share price feel the impact.
