Why Do Companies Give Guidance?

If I was running a public company, I would not give investors and analysts any type of precise financial guidance. Giving such sales and profit estimates stems from the implementation of Regulation FD, which required companies to divulge all meaningful information to the public, not just Wall Street analysts and boards of directors. No longer faced with having the luxury of “guiding” analysts to how a particular quarter was tracking, companies began issuing financial guidance in their press releases for everyone to see and interpret.

Unfortunately, earnings guidance plays right into the hands of those who focus too much on short-term financial performance, as opposed to building long-term shareholder value. CEO’s should not make business decisions in order to ensure they can make their numbers every quarter, but instead because it is in the best interest of the company and its shareholders long-term.

Making sound decisions that succeed in hitting both short-term and long-term goals is not always possible. Sometimes corporate managers have to make short-term sacrifices to ensure long-term stability and growth. Examples of these actions might be a dilutive acquisition, or price cutting to prevent a key customer from bolting to a competitor. Price discounts and dilutive deals will cause many companies to miss a quarter or two, but investors will be much better off five years later.

The fact remains that Wall Street focuses too much on quarter-to-quarter financial results. Investors see this every day when companies miss their EPS numbers by a penny or two and their stock drops 10, 20, or 30 percent in a single day. As a result, CEO’s begin to manage their business just to make sure they hit their numbers.

Taser (TASR) shipped out a $1 million order on December 31, 2004 to ensure they hit Q4 profit estimates. Pharmaceutical companies convinced wholesalers to take delivery of more product than they needed (a tactic called “channel stuffing”) so sales would be on target. According to court records, former WorldCom CEO Bernie Ebbers agreed to cook his company’s books because they needed to “hit their numbers to keep the stock price up.”

Finding companies that manage their businesses based on strategic plans, and not their public financial guidance, will do a much better job over the long term, and that’s something investors should look out for.

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2 Thoughts on “Why Do Companies Give Guidance?

  1. Anshu Kalhan on February 24, 2005 at 2:53 PM said:

    Good post Chad. I too am not a huge fan of company guidance, but moreson I’m not a huge fan of sell side analysts. One of the bigger problems that I’ve seen that causes short-term stock price volatility is when analysts interpret company guidance to be “conservative” or “aggressive” and thus the analyst’s estimates for the company are materially higher or lower than what the company is guiding to. In my experience, I have seen our company hit our guidance range dead center, but because analysts viewed our guidance as “conservative”, our stock took a dip due to missing consensus. Seems ridiculous for a stock to drop 4-5% in one day simply because analysts chose not to listen to your guidance. I agree with you in the long run shareholder value is created not through making/missing estimates and guidance, but by sounds decisions that achieve long term goals, but it is awfully frustrating to see these fluctuations in the short term are often caused by the Street refusing to listen to company guidance.

  2. Chad Brand on March 4, 2005 at 4:45 PM said:

    You’re right, the short-term fluctuations caused by the silliness of the system as it works now is frustrating, especially from the corporate perspective.

    As an investor though, you can at least profit from the fluctuations that always seem to present themselves. That’s how I’ve learned to love it when it does occur. My eyes just light up, but sometimes it takes discipline to step up to the plate and take action when you seem to be in the select minority.

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