With the end of the third quarter just around the corner, investors can probably expect another round of earnings reports in which many publicly traded companies offer no guidance on future earnings. This will once again serve as a source of anxiety for some investors, who could feel they are missing out on a key insight into where the companies they own plan to be in the coming months.
The typical new excuse for not offering guidance is, of course, the Covid-19 pandemic. In many industries, such as travel, leisure and restaurants, this is to be expected, as no one is certain when demand will return or whether or not governments will impose further lockdown restrictions in the near term.
However, uncertainty on the future does not account for all instances of missing guidance. Some companies, such as egg producer Cal-Maine Foods (CALM, Financial), CarMax (KMX, Financial) and Dollar General (DG, Financial), have pulled their guidance despite seeing highly predictable (and often higher) earnings results in recent quarters.
With the high level of predictability of many of the businesses refusing to offer guidance, there are likely other factors at play that have nothing to do with uncertainty about the future. Let's take a look at some of the other driving factors behind the "no guidance" trend, and how the shift could affect markets in the future.
A fight against "short-termism"
After about 40% of S&P 500 companies dropped guidance due to the pandemic, only one in five companies on the index still provide quarterly earnings guidance. Thus, although the pandemic has seen a dramatic drop in the number of companies that are offering guidance, some had already nixed the practice beforehand.
Before the pandemic, the push for companies to drop Wall Street-style earnings predictions came from those who consider such numbers to promote unhealthy short-term viewpoints among investors. The idea here is that too many predictions encourage people to buy and sell more every time quarterly earnings come out and the company either misses or surpasses the guidance numbers it previously issued.
"Quarterly guidance," Dimon said, "can often put a company in a position where management from the CEO down feels obligated to deliver earnings and therefore may do things that they wouldn't otherwise have done."
In the past, Buffett has also argued multiple times that guidance numbers result in a more flighty, short-term-focused investor base and can often drive away more desirable long-term investors.
There is also the effect of guidance-based valuation systems on company culture. Scott Galloway of NYU's Stern School of Business commented the following in response to the interview mentioned above:
"When you pay CEOs based on earnings, and the metric is quarterly earnings, and the compensation committee says 98% of your compensation is going to be based on the stock price, which investors have linked to the earnings, compensation drives behavior."
In other words, because executives tend to operate their companies in such a way as to maximize their own compensation whenever possible, eliminating quarterly guidance numbers could eliminate the issue of executives making decisions that harm the company's long-term prospects in order to bag an earnings win in the short term. Such harmful decision could include things like issuing new debt in order to decrease the share count, making ill-advised acquisitions (or, as Peter Lynch would call it, "diworseification") to fuel non-organic growth, etc.
Thus, over the long term, cutting guidance permanently could help companies perform better in the future. Of course, this wouldn't eliminate short-termism entirely, as companies can do nothing to stop Wall Street from issuing its own predictions.
Protecting stock prices
On the flip side, many investors may feel uncomfortable when a stock stops issuing guidance, as they may feel like the company has something to hide. If no guidance is offered, is it because the company expects to do very poorly and does not want to see a selloff on its stock?
For example, Accenture PLC (ACN) reported guidance with its most recent earnings results last week. While the company expects growth, its own predictions of growth were lower than what Wall Street was hoping for, contributing to a drop in share price:
Thus, not reporting guidance could potentially lead to higher investor optimism (and, therefore, higher share prices) than reporting guidance that may or may not live up to expectations. Increased willingness to overlook short-term losses in light of the bigger picture could lead to more consistent overvaluation, increasing volatility when faced with shocks such as Covid-19 and discouraging research into whether losses are short-term or could represent more permanent damage. One could argue that ditching guidance is one of the reasons why the S&P 500 is up year to date despite the economic recession in the U.S., though there are far too many confounding factors here to draw any conclusion.
There are many benefits to companies having higher stock prices, which means that if it really is the case that pulling guidance leads to share price improvements, then companies have a major incentive to ditch the projections.
One such benefit is debt. The higher a company's share price, the easier it is to raise large amounts of capital with new common stock issuances. Other benefits include cheaper acquisitions (i.e., it has to issue fewer shares in stock-based transactions), increased reputation among customers and higher payouts for employee and executive stock option compensation plans.
There are pros and cons to companies ditching specific guidance. In the long term, it could be a beneficial move in terms of discouraging short-termism, though this has the potential to result in consistently higher market valuations, especially with more money flowing to stocks as bonds yield practically nothing. On the other hand, the fact that Covid-19 has companies quickly ditching guidance in order to preserve their share prices is in itself short-termism and could be an indication of underlying trouble in companies that take this route – even if investors don't realize it.
Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research and/or consult registered investment advisors before taking action in the stock market.
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