What Is Company Guidance on Earnings, Its Impact and Risks?

What Is Company Guidance?

Guidance is an informal report a public company issues to shareholders detailing the earnings it expects to achieve in the upcoming fiscal quarter or year ahead. Guidance, also referred to as forward earnings guidance or a forward-looking statement, typically includes internal projections for revenue, earnings, and capital spending and is subject to revision in the interim.

Guidance can be contrasted with analysts' estimates, which are generated by external experts.

How Company Guidance Works

Company guidance is typically released immediately after a company publishes its latest quarterly earnings report and is often discussed in depth during a meeting between industry analysts and company executives. Companies are not legally required to provide earnings guidance, although it is common practice for many of them to do so.

The information guidance is based on normally includes sales projections, market conditions, and anticipated company spending. Some companies provide guidance on other aspects of their financial activities, too, such as inventory, units sold, and cash flow.

Impact of Company Guidance

Providing forecasts to investors is one of the oldest Wall Street traditions. In earlier times, earnings guidance was called the "whisper number." The only difference is that whisper numbers were given to only selected individuals, such as analysts or brokers so that they could inform their big clients. Fair disclosure laws, known as Regulation FD, made this illegal, and companies now have to broadcast their expectations to the world, giving all investors access to this information at the same time.

Any comments management make about the company's future prospects are studied closely by investors. An inside perspective on how business is faring since the last figures were collected, and is likely to develop in the coming months, can potentally trigger a share price rerating.

Guidance reports tend to significantly influence analysts' stock ratings, which affect many investors' decisions on whether to buy, hold, or sell a stock. For example, if a company's management dispenses guidance figures that fall well below market expectations, a number of analysts will probably downgrade the stock, causing many investors to dump it.

Special Considerations

There is always a risk that a company's guidance may turn out to be wrong. Few investors mind if the company low-balls its estimate. Many are irate if they miss their stated goals.

In the U.S., safe harbor provisions protect companies from being sued if they fail to meet their own forward-looking expectations. Most notably, in 1995 Congress enacted the Private Securities Litigation Reform Act (PSLRA), which helps shield companies from securities fraud lawsuits stemming from unachieved expectations.

A Word of Warning

To further protect themselves from lawsuits, companies pair their guidance reports with disclosure statements maintaining that their projections are by no means guaranteed.

Companies are under no obligation to update their guidance after initial reports are issued, even if subsequent events render their projections unlikely. Some do, however, in order to get the bad news out there before the earnings release date.

Advantages and Disadvantages of Company Guidance

Some in the investment community feel that guidance does a company and its investors more harm than good. Investment guru Warren Buffett recently called for companies to stop issuing quarterly earnings guidance. He believes that it forces companies to place too high a priority on making the numbers at the expense of nurturing the long-term interests of the business.

Others disagree, believing that quarterly earnings reports cause investors to become more educated about short-term results versus long-term initiatives. Proponents also believe that providing less information to the public would not inevitably reduce stock volatility.