Companies that provide quantitative guidance with earnings announcements see better stock returns than those that do not
A new study suggests that offering earnings guidance might be one of the best tools to increase the market value of a company.
According to an analysis of approximately 1,000 publicly traded companies, there is an association between ‘greater transparency’ and ‘abnormal market returns’, with companies that offer guidance generally performing better than those that do not.
The study, from web-based research platform vendor IntelliBusiness and IR agency Sharon Merrill Associates, mirrors a study the two groups carried out in 2009.
The report takes a short-term focus on results, as quantifying the relationship between long-term actions and quarterly guidance would be difficult. In that window, the market seems to favor guidance, even if a company misses expectations or its own previously offered guidance.
During 30-day periods around earnings announcements – 10 days before and 20 days after – the study finds the following:
– Companies that provide quantitative guidance with earnings announcements see stock returns by no later than 20 days after the announcement that are superior to companies that do not, whether the companies in question beat or miss analyst consensus EPS estimates.
– The market puts ‘greater emphasis on performance above or below analyst consensus estimates than on performance versus company guidance.’ That is different from 2009, where the market emphasis was put on beating guidance, and may indicate ‘an important transition of investor psyche,’ according to the two groups.
– Smaller-cap companies see greater volatility in results than large caps but, in either case, ‘providing updates to guidance within the context of reporting their quarterly results helps lock in price appreciation or mitigate downside, depending on whether news is good or bad.’
In short, companies that offer forward-looking guidance when they release earnings can improve valuation, whether adding to increased valuation or reducing a drop, depending on the earnings results.
If results fall below previous guidance, pre-announcing the miss generally results in higher performance than announcing the miss only on the earnings release.
The practice of offering guidance is not without critics. Warren Buffett has advised companies against providing guidance because it focuses managers on short-term gains rather than long-term value.
