Why Eliminating Guidance is a Big Mistake

Here we go again. The latest attack on quarterly earnings guidance comes from the Aspen Institute, a non-profit organization that according to its website is "dedicated to fostering enlightened leadership and open-minded dialogue." Promoting the elimination of guidance, however, is anything but enlightened. So, in the hope of fostering some dialogue, here is my argument against eliminating guidance.

There is a widespread misconception that earnings guidance is bad because it causes investors and corporate executives to focus on short-term results rather than the long term. While no one doubts that running a corporation with the long term in mind is the better approach, it is wrong to believe that guidance is the problem. Investors certainly do focus on quarterly earnings numbers, but not because corporations give out guidance. They focus on quarterly results for only one reason--the SEC requires corporations to report results on a quarterly basis. It is because of this SEC requirement that investors form quarterly expectations. If the SEC told corporations to report results on a monthly basis, investors would form monthly expectations. This has nothing to do with guidance. Eliminating guidance will in no way stop investors from forming expectations.

Guidance is valuable information. After all, who knows better what a corporation is likely to earn, a bunch of Wall Street analysts or the corporation's own management? If guidance is not provided, analysts' earnings estimates will simply become more inaccurate. Earnings surprises would become bigger. By the way, there are at least two academic studies in circulation that prove this point. And in an era in which regulators are trying to promote more disclosure, how much sense does it really make to tell corporations to stop providing guidance?

The truth is that those who want to end guidance are upset about the volatility that occurs when corporations miss the earnings estimate by just a penny or two. They believe the ensuing sell-off is unjustified. They are probably right about this. However, instead of grabbing the opportunity to buy more shares at a lower price, as any self-respecting long-term investor should do, they want to eliminate volatility by eliminating guidance.

Furthermore, if they would really like to see a greater focus on the long term, perhaps they should petition the SEC to eliminate quarterly reporting altogether. There was a time when corporations had to report results just once a year. However, many corporations reported quarterly results long before a change in the law required them to do so. They did this for one simple reason: their investors demanded the information. This is exactly why corporations provide guidance. If investors want quarterly guidance, should we not be encouraging corporations to provide it?

Counterpoint: Aspen Principles Aim to Stop Earnings Guidance: Hallelujah! (Henry Blodget)

Comments

[wixeywaxy:]

Your comment sounds good to anyone not familiar with accounting in a large corporation. The fact is that earnings are not at all predictable quarterly in most corporations and the management people are the most aware of it. The result of having to artifically set numbers to please Wall St. and it analyst is the setting up of all kinds of reserves that can be adjusted to smooth out the numbers. There are many accruals and deferred accounts that are fuzzy enought to add some more places to make the numbers match the earlier guess. Management doesn't want to do this and I respect those that have told the Wall St crowd we aren't going to do that anymore. One thing it does is create incentives inside an organization to fudge the numbers being sent for consolidation because the departments are under pressure to never have any surprises which isn't the real world. Investors for the most part don't understand the workings of accounting in very large businesses. It's a nightmare of problems to assemble information from operations scattered all over the world and there are a gillion fuzzy elements to nail down. Accounting is not all that black and white as most people imagine and the IRS and other government regulations contribute to the obfuscation. Just like the IRS code everything they claim to make simple gets more complicated and worse. Vic

2007 Jun 19 12:23 PM

[paul:]

Amen! Anyone that has been an officer of a corporation knows the amount of guess work that goes into any guidance. This is especially true when quarterly turns business is a significant portion of the revenue.

2007 Jun 19 01:17 PM

[Paul Meisel:]

Double amen. The amount of judgment involved in forecasting the timing of project completion, weather issues, billing issues and accruals makes guidance very difficult, and it makes the company no more money. It is a waste of time for the long term investor.

2007 Jun 19 05:08 PM

[uurum:]

I believe it will be good to eliminate guidance. There are no consistent rules across firms on what standards "guidance" will conform to. Whatever information is needed by investors to make decisions should be specified by accounting law. IMHO, quarterly earnings reports is enough.

2007 Jun 19 01:45 PM

[huangjin:]

Companies should be focused on building long-term value for shareholders. I think it's mostly traders that want quarterly guidance. But if a company gave no guidance, and then missed big, investors would cry foul.

2007 Jun 19 02:47 PM

[Russia Guy:]

Of course no one knows better than the corporation how much it going to earn. But they have not - or should not have - achieved their positions because of their ability to predict the future. Helping analysts not make mistakes in their earnings estimates is certainly not the role of a corporate executive. There are two academic studies to prove every asserted position, right or wrong, ridiculous or not. For more than 70 years regulators have been promoting disclosure - of facts, not of guesses about the future.

Have you forgotten Yogi Berra's concept: "Making predictions is very difficult, especially about the future."

2007 Jun 19 04:14 PM

[John Rosevear:]

I want management that is focused on management, not wasting time on fudging numbers to satisfy Wall St know-it-alls. You say:

<i>If guidance is not provided, analysts' earnings estimates will simply become more inaccurate.</i>

... but you haven't established why management should care. Over the long term, the business results will speak for themselves and the stock's price will find its way accordingly. In the short term... what vicvw said.

2007 Jun 19 04:20 PM

[KillerKev:]

So why does the world need security "analysts" if all they do is copy what management says?
If people invest in a company based mainly on their guidance, this public info will be reflected in the stock price then how can I make money? What a lame article from a media 'expert'....

2007 Jun 19 05:18 PM

[jbs:]

"If investors want quarterly guidance, should we not be encouraging corporations to provide it?"

Investors are increasingly saying they don't want it. That's kind of the point.

Most of the companies I own don't provide guidance and I'm fine with that. "Analysts" care because its the basis of their reports, which arguably add little value anyway.

2007 Jun 19 09:37 PM

[Sonia Mirza:]

Waste of time or not...inaccurate or not...it is a necessary evil, isn't it?
The long term investor sees no use in the job of a day trader...
The buyer of ___ see's no use for ___ in their portfolio
and then snickers at the uninformed party who was on the opposite side of his position...

like it or not, this is all part of the lubrication that ensures all the gears shift smoothly

While it might be hard for mgmt to predict accurately what the outcome might be, it gives that day trader something to play on, the newbie interns at GS (or insert name of IB here) a 12398 page report to write about to impress their bosses...and others perhaps a chance to enter/exit the market/rebalance etc etc

2007 Jun 19 11:08 PM

[Zachary Sch...:]

I think the markets are relatively efficeint. Any academic would tell you they are fairly close. If we have a efficient market, a stock that trades off based on a poor quarterly number will be bought by wise investors who have a better understanding of long-term trends (assuming the company is still just as viable as before). This quarterly disparaging should be looked at more from an opportunistic standpoint than one that causes us concern. If investors demand quarterly reporting, and then are going to make poor decisions based on this quarterly information, this gives a more rational investor a wonderful time to take advantage of the additional volatility.

2007 Jun 19 11:48 PM