Allow the hysteria of earnings guidance to die

The coronavirus crisis imposes uncertainty, making it difficult to provide earnings outlook

With earnings season in full swing, one notable phenomenon in the stock market these days is that many firms have withdrawn financial guidance — a forward-looking statement to investors which includes revenue estimates and projected earnings — for the remainder of the year. Based on an analysis by IR magazine, since mid-March, 779 companies have withdrawn annual guidance and 69 companies have withdrawn quarterly guidance.

One of these companies is tech giant Apple, which withdrew quarterly guidance for the first time in more than a decade. Amazon.com, on the other hand, provided a very wide range for its operating income next quarter — between a loss of $1.5 billion and a profit of $1.5 billion, and added a disclaimer that even this rough estimate is “subject to substantial uncertainty.”

Clearly, the coronavirus crisis imposes an extreme level of uncertainty on firms, which makes it very challenging for them to provide earnings outlook. But it’s a good time to ask whether providing quarterly guidance is useful even in normal times.

According to a survey by McKinsey and Company, the benefits executives attribute to the practice include higher stock valuations, lower share-price volatility, and improved liquidity. Moreover, some view it as a necessary channel of communication between the firm and financial-markets participants.

But a 2017 study — Moving Beyond Quarterly Guidance — by the non-forprofit group FCLT Global (Focusing Capital on the Long Term) shows that no empirical evidence supports these attributions.

On the contrary, the practice of providing quarterly guidance — which gained popularity in the 1990s and reached its peak about a decade ago — has been criticized by many as a practice that creates short-termism among executives, who come to focus mostly on short-term goals and on beating analysts’ expectations, as opposed to creating long-term value for shareholders and other stakeholders.

Larry Fink, the CEO of BlackRock, the world’s largest asset manager, went as far as describing the practice as “quarterly earnings hysteria” in his 2016 annual letter to CEOs of S&P 500 firms. Fink argues that CEOs should focus more on demonstrating progress with long-term strategic plans than on a “one-penny deviation from their earnings-per-share targets or analysts’ consensus estimates.”

In agreement, Business Roundtable, an association of nearly 200 CEOs from major U.S. companies, announced in 2018 its support for moving away from providing quarterly earnings guidance. It called for corporate strategies with the goal of producing sustainable value creation for long-term prosperity, not to meet the latest forecast.

Despite that, many firms continue to provide financial guidance, and some executives believe that the practice has merit. A close friend of mine who holds a senior position at a Silicon Valley firm argues that quarterly guidance creates “an effective mechanism to motivate and engage employees to meet specific goals every quarter.” He adds that “the reality is that we all need a bit of a push, and the process makes everyone work harder.”

In this context, it is important to distinguish quarterly guidance from quarterly reporting. The latter remains key. While staying away from quarterly guidance, firms are obliged to and will continue to provide their annual and quarterly results which highlight current performance. This will let investors, analysts and other stakeholders assess the health of firms using the most recent data.

There is no specific requirement in securities laws in Canada or in the U.S. to issue earnings guidance — it’s all provided voluntarily by companies, and it’s at a firm’s discretion to decide whether or not to discontinue it. Eliminating the practice widely will cut off firms from the stigma associated with withdrawing guidance, which is often followed by a painful decline in the stock price.

Many firms have recently suspended financial guidance due to extreme uncertainty around the COVID-19 crisis. This creates an opportunity to end the practice altogether, now that it is found to be mostly counterproductive.

A better alternative would be to provide investors with a long-term path of a company’s strategy over three to five years, combined with financial and operating metrics. Stakeholders will have the confidence and transparency they need, and the company will avoid shortterm myopia and unneeded pressure to beat analysts’ expectations by a penny.