Receiving Guidance

Why do companies provide quarterly earnings guidance?

Photo: Michael Richter. Source: Morguefile

Every few months we hear about companies that beat expectations for their quarterly earnings, or fall short, or do something different. Sometimes there are business combinations or spin-offs that confuse the issue. Other times the accounting profession changes the way corporations need to report their financial numbers.

Some CEOs criticize the market’s quarterly earnings derby. They note that quarterly earnings reports are more art than science. Quarterly numbers aren’t even audited – they’re estimates of what’s happened over the past three months. Some firms have done away with providing guidance about what they think the next quarter will bring. Jaime Dimon, CEO of JP Morgan, put it this way: “You don’t know what’s going to happen every quarter. I don’t even care about quarterly earnings.”

He has a point. Quarterly estimates can’t predict one-time events, which by their nature are unexpected. And managers should focus on building the long-term value of the business franchise. But it’s all well and good for Jaime Dimon to stop providing guidance. JP Morgan is one of the largest banks in the world. Analysts need to follow them and provide their own estimates for investors.

But smaller companies don’t enjoy Dimon’s privilege of being 3% of the S&P 500 or one of the Dow Jones 30 Industrials. Most companies need to establish their credibility – their budget discipline, their market growth, and – most importantly – their capital allocation process. To do this, they need to provide earnings guidance and then execute a business plan that meets that guidance. Making and keeping your promises is the best way to build credibility, over time. And having established themselves, it’s hard work to maintain a solid reputation. Investors are right to be skeptical. After all, it’s their money.

Problems arise when making or beating a quarterly earnings estimate becomes the be-all and end-all of corporate management. After all, there’s a rule-of-thumb for analysts that says when a measure becomes a target, it ceases to be a good measure. Sales professionals who understand the new commission scheme will game the system to maximize their income. It’s important that quarterly earnings and revenue performance not be the only measure of success.

But they’re not irrelevant. Short-term performance matters. Some investors don’t have a long-term perspective – elderly individuals with significant embedded gains. And in any case, we have to get through the short-term to get to the long-term. Japan was focusing on long-term projects in the ‘80s. The problem was, they lost discipline over expenses, and when long-term growth prospects collapsed, companies appeared far too bloated.

Quarterly earnings estimates provide accountability for managers and information to investors. A firm that can credibly keep its promises will be rewarded with a higher valuation and a lower cost of capital. At least, that’s how it’s supposed to work.

Douglas R. Tengdin, CFA

Charter Trust Company

“The Best Trust Company in New England”

By |2018-06-25T17:01:00+00:00June 25th, 2018|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

Leave A Comment