In the past two posts, I’ve examined the investor relations minefield commonly known as guidance – the practice of telling investors what you think future earnings may be.
It is a practice fraught with difficulties, not least of which is that companies often get it wrong. The business of forecasting is, by its very nature, an uncertain one, and the opportunities to go astray are numerous.
However, because the market is focused on future cash flows as a means of valuing a company, investors will make an estimate of upcoming earnings whether the company helps them or not. And if they don’t help in some fashion, the dispersion of estimates will be wider than if investors had received some input from the company. Companies don’t like widely dispersed estimates and therefore often wind up issuing guidance. But the input companies give to lower estimate dispersion doesn’t have to be guidance.
Guidance is merely the result of a series of inputs and estimates the company has made. Rather than give the market the estimated answer, companies can just as easily give investors the estimates for some of the inputs to the equation. If the company supplies its estimated ranges for the major components of the income statement; revenues, expenses and anticipated changes to the tax rate, investors will be able to draw their own conclusions as to earnings.
Alternatively, a company can increase the amount of interim information it makes available as a way of avoiding guidance. Many companies tend to be “black boxes” in between reporting periods. This is unfortunate, because the ideal of a good corporate disclosure program should be to dispense enough information, and update the information frequently enough, so that investors are able to reasonably reach informed decisions about how you are performing. For example, many retailers put out monthly sales numbers. By the time quarterly earnings come around, everyone knows the sales number for the quarter. For many companies, this eliminates guessing around one of the more uncertain numbers on the quarterly income statement and reduces the need for guidance.
If company management really means it when they say they are running the company for the long-term, then consider telling the market what your long-term goals are, and how you’ve performed against them. An example here might be, “We expect that on a three year rolling average our sales growth will be between 8% – 10%. With sales at this level, we believe that we should be able to lower our expense ratio by about 1% – 1.5% per year. This should give our earnings growth a trend line in the high single digit to low double-digit range. This may not occur every year, but we expect things to average out in that range.”
Finally, at the far end of the spectrum, consider reporting unaudited earnings more frequently. Progressive Insurance, an American automobile insurer, reports its income statement and balance sheet monthly. Since it began doing so, its stock volatility has declined noticeably, as it has eliminated uncertainty by increasing information flow.
Lucy is Editor at Corporate Eye
