Printer Friendly Version
Market Turmoil Leads Companies to Rethink Projections
In making projections of sales and earnings growth, some BetterInvesting members look to company guidance for help. But the uncertainty surrounding the credit crisis has made doing this more difficult. More companies are either abandoning earnings guidance or offer fewer projections, as the ability to gauge future performance becomes trickier in volatile markets marred by corporate failures and crumbling confidence in the capital markets.
Still, company predictions of its revenue and earnings growth serve as a key barometer even for some of the savviest investors. Companies are under pressure to “beat the Street” or exceed analysts’ consensus estimates, which take into account a company’s own forecast. Such a feat is often correlated to a stock’s movement and influences decisions to buy, hold or sell shares.
Corporate earnings releases, especially surprise announcements of a larger-than-expected profit or loss, often send stocks soaring or sinking. These swings can be lucrative for traders who act on the roller-coaster market but are particularly confusing for long-term investors. Some of the world’s biggest investors ignore company guidance completely. Warren Buffett, for example, believes these estimates only confound investors. As a major shareholder in Coca-Cola (ticker: KO), he persuaded the beverage giant to stop issuing earnings guidance in 2002.
Forward-looking statements on profit and revenue are often unintentionally misguided, as unexpected currency fluctuations, unplanned mergers and acquisitions, increased competition and general changes in the market can dramatically alter the course of a company’s growth. Analysts revise their estimates throughout the quarter, turning the focus away from a longer-term outlook. It’s best to focus on your own analysis of a company’s past profitability and revenue growth over time. Barring major changes in a company’s structure, that’s the best indication management will continue to generate long-term growth.
Wall Street analysts’ consensus estimates are closely watched by investors who measure stock performance on the basis of a company’s earnings power. Big banks such as Citigroup (C) and Goldman Sachs (GS) have teams of analysts assigned to particular stocks who write and distribute reports on companies’ projected earnings by quarter and full fiscal year.
Short-term stock movements often are related to expectations. When a firm reports a loss, its stock may surge as long as it beats the Street by as little as a penny.
A consensus forecast for a major blue chip company could be an average of two dozen analyst estimates, while a smaller company may be monitored by just one or two analysts. Thomson Reuters, Bloomberg and others collect estimates and calculate the average or consensus found in most news reports on earnings.
Other consensus estimates are available online on the myriad financial news and information websites. Major institutional investors, including pension and mutual fund managers, rely on consensus estimates, as they lack the resources to track thousands of publicly traded companies.
A company’s decision to cease or curb guidance can alter consensus estimates, widening the gap between forecasts and results. And a July 2009 report “Earnings Guidance, the Current State of Play” by Deloitte LLP and the Financial Executives Research Foundation determined that although no one factor is to blame for the financial crisis, many senior financial executives are again weighing the benefits and risks associated with publishing forward-looking earnings guidance.
A survey released in May 2009 by the National Investor Relations Institute found that 60 percent of respondents were giving their shareholders earnings guidance, compared with 64 percent in 2008. Respondents cited greater difficulties in their companies’ ability to predict earnings, presumably because of the economic crisis, as the reason for abandoning guidance.
The survey of 515 investor relations professionals showed that 84 percent were continuing to give guidance to keep analysts’ and investors’ expectations reasonable, while 46 percent were doing so to try to limit volatility in their stock price. Nearly half the respondents that no longer provided earnings guidance stopped the practice in the first half of 2009, as chief financial officers sought to shift investors’ attention to other metrics such as expected revenue, same-store sales or capital expenditures.
Aetna (AET), General Electric (GE), Ingram Micro (IM), Intel (INTC), Knoll (KNL), Nexstar Broadcasting (NXST) and Unilever (UL) are among the companies that have scaled back or scrapped quarterly earnings guidance, opting for full-year projections.
Companies will continue to tinker with their guidance policies as the economy recovers and markets evolve. Consider corporate forecasts and consensus estimates along with other factors, such as long-term cash flow, whether a company has paid consecutive dividends, its management and its corporate structure, to make the most informed decisions.