Every year, and often every quarter, a large number of publicly listed firms- particularly in the United States, release company guidance. They’re under no obligation to do so, and it's always been a topic of debate among experts, but many believe that providing investors with financial performance information and guidance is simply good business.
The practice of releasing performance forecasts has been around for many years, and research shows that it boosts analyst following, and may prevent unexpected performance shocks. This in turn might reduce stock price volatility and the danger and implications of shareholder litigation. Publishing such predictions doesn’t guarantee their accuracy, and to avoid the possibility of lawsuits, businesses have to include disclaimers with their guidance reports.
Read on to gain a deeper understanding of the concept of company guidance, so you can decide for yourself if it will form a part of your future research strategy.
What is company guidance?
Typically, a firm's guidance is issued shortly after the publication of its most recent quarterly earnings report. The information it contains is often reviewed in detail at a meeting between industry analysts and company management before being released to shareholders and the public via company regular reports, press releases, and earnings calls.
Depending on the preference of the company, sales predictions, market circumstances, and projected corporate expenditure will constitute the basis for the report. Some firms also offer recommendations on their inventory, units sold, and cash flow, among other areas of their financial activity.
Popularity for the practice has moved in ups and downs. After the US Congress decided to shield businesses from responsibility for comments about their future performance, the practice of offering earnings guidance spread widely in the second part of the 1990s. Notably in recent times during the volatility of the pandemic, many have put them on pause.
When they’re released, investors will generally pour over statements made by management on the company's future prospects to gain a deeper understanding of the company. While analyst’s careful assessment of the company's progress since the last set of data was generated, as well as expectations for the next months, might lead to a revaluation of the stock price.
Many investors' choices on whether to purchase, hold, or sell a company’s shares are impacted by these analysts' stock ratings. For instance, if a company's management provides guidance numbers that are much below market expectations, many analysts would likely assign a lower value to the stock, encouraging many investors to sell.
Pros of following company guidance in your trading
- It might help your decision-making process
Getting the inside scoop into the financial progress of a company is a great way to round out your research, especially if the guidance proves accurate. Management has a deeper understanding of the company and a wider range of data from which to draw conclusions than any analysis group.
- You’re able to evaluate the management of the company
Understanding the calibre and experience of a company's management is essential to accurately predicting its future performance and profitability when doing an analysis of an equity investment.
Cons of following company guidance in your trading
- The guidance might be wrong or misleading
It is possible for guidance numbers to be missed or misconstrued. Worse still, they could be manipulated to influence investor behaviour. There is a view that management utilises guidance to "walk down" market expectations so that the business may outperform analysts' consensus earnings projections when the company's actual results are published, thus they need thorough scrutiny.
- The information could be out of date
After initial reports are given, companies are under no obligation to change their recommendations, even if later developments make their estimates implausible.
- You might lose sight of the big picture
Many investors would do well to stop focusing on short-term performance and instead look at the factors that affect a company's long-term health, as well as their goals and expectations for the future.
Why are some companies no longer providing it?
Some in the financial community are of the opinion that providing guidance is more likely to hurt than help a business and its shareholders. Well-known investor Warren Buffett recently urged businesses to abandon quarterly profit forecasts. According to him, this system compels businesses to put short-term profit concerns ahead of the company's long-term health. “I think it’s a very bad practice to be in the game of earnings guidance, and it is a game.” He said.
Many companies also suspended their guidance policies over the past few years during the pandemic. Throughout the first phases of responding to the crisis, asset values and company operations fluctuated wildly, making it virtually impossible to make accurate performance predictions for any period of time beyond the following week.
Due to the unpredictability of many factors, many companies ceased making forecasts rather than risk missing the mark. Some of them have since not returned to the practice or are still yet to return to it in the face of persistent global economic uncertainty.
Summary
Keeping a close eye on company guidance is just one of many tools that investors can rely on as part of their research. A lot of great companies provide it, and a lot of them don’t.
As there is generally some bias towards low-balling results to allow companies to beat expectations, investors should always take these forecasts with a grain of salt.
One example of a time to take notice of guidance, however, is when companies are promoting very positive future results. Companies will always try to avoid missing their estimated growth, so one could assume a positive guidance means there is reason to be confident.
The information provided does not constitute investment research. The material has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and as such is to be considered to be a marketing communication.
All information has been prepared by ActivTrades (“AT”). The information does not contain a record of AT’s prices, or an offer of or solicitation for a transaction in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information.
Any material provided does not have regard to the specific investment objective and financial situation of any person who may receive it. Past performance is not a reliable indicator of future performance. AT provides an execution-only service. Consequently, any person acting on the information provided does so at their own risk.