To issue quarterly, or not to issue?
‘Most companies view the quarterly ritual of issuing earnings guidance as a necessary, if sometimes onerous, part of investor relations.’
The war on issuing quarterly quantitative guidance has been ongoing for at least 10 years, since an influential McKinsey study – from which the above quotation was taken – came out, claiming that none of the practice’s benefits rang true.
Share price volatility was the same for companies that did or did not offer guidance, the study found, valuations were unaffected, total shareholder returns were the same and, as far as liquidity was concerned, the increase in trading volumes for those issuing guidance benefited short-term traders alone.
The 2005 McKinsey report the study was based on, Weighing the pros and cons of earnings guidance, did not start the debate about quarterly guidance but it did ignite it. Since then, academics, investors, consultants and corporations have been trying to get companies to move away from this form of short-termism through the Focusing Capital on the Long Term campaign.
Most recently, a consortium of investment and corporate leaders, including Jamie Dimon of JPMorgan and Larry Fink of BlackRock, took aim at quarterly guidance in the publication of their Commonsense Corporate Governance Principles, saying: ‘A company should not feel obligated to provide earnings guidance…. Making short-term decisions to beat guidance (or any performance benchmark) is likely to be value-destructive in the long run.’
The campaign has had its effect. According to the most recent NIRI 2016 survey of best practices in the US, only 29 percent of companies now provide quarterly financial guidance, compared with 67 percent that provide annual guidance.
Pros
While issuing quarterly guidance has been accused of encouraging short-termism, however, there are advantages, even necessities, for some sectors to issue shorter-term guidance than annual. Mike Piccinino, a managing director on the medical device and diagnostics team at Westwicke Partners, a healthcare-focused IR capital markets advisory firm in the US, points to the necessity of some – very seasonal – industries issuing shorter-term guidance. The market expects the retail industry, for example, to issue fourth quarter guidance. If it did not do so, the market reaction would be extremely negative.
‘Many companies have adopted the practice of providing guidance for financial performance in the next fiscal quarter,’ notes Piccinino. ‘Providing visibility into the company’s near-term expectations may help investors and analysts appreciate how growth and profitability trends may change as the year progresses – seasonality, competition, new product launches, and so on – can all impact the cadence of performance throughout the year.
‘Ideally, we favor a hybrid approach of providing annual guidance at the beginning of the year and supplementing this outlook with guidance for each upcoming quarter. This can help the Street clearly understand any quarter-to-quarter volatility and can alleviate the risk of an unintentional quarterly ‘miss’.’
Cons
The McKinsey study outlined the disadvantages of issuing quarterly guidance in a way that has been repeated frequently, and even has echoes in objections in the latest Commonsense Corporate Governance Principles: ‘The difficulty of predicting earnings accurately, for example, can lead to the often painful result of missing quarterly forecasts. That, in turn, can be a powerful incentive for management to focus excessive attention on the short term; to sacrifice longer-term, value-creating investments in favor of short-term results; and, in some cases, to manage earnings inappropriately from quarter to quarter to create the illusion of stability.’
Piccinino acknowledges this potential problem. ‘I think the market is most concerned with management teams that may be passing on the right strategic opportunity for the long term by placing undue emphasis on how it may impact their ability to meet the next quarter’s profitability guidance,’ he says.
Respondents to the 2005 McKinsey study said demands on management’s time were the biggest cost of issuing quarterly guidance, followed closely by the indirect cost of a short-term focus. They also noted demands on other employees as a cost disadvantage.
How to terminate quarterly guidance
In 2014 Gabriel Karageorgiou, Daniela Saltzman and George Serafeim, writing in the Harvard Business Review, offered a series of best practices to adopt if a company decides to move away from the issuance of formal quarterly quantitative guidance, noting that if such a decision has been made it must be communicated by the CEO or the CFO to have conviction.
They said:
1. Clarify that stopping guidance is not a sign of increased uncertainty or economic conditions, rather an effort to establish practices that emphasize long-term value creation
2. Reinforce step one by confirming guidance numbers for the same period and issue one last set of guidance numbers for the following period when you announce your decision to end issuing earnings guidance
3. Highlight that your board agrees with the decision, suggesting that this is a strategic, thoughtful choice that has received broad support internally
4. Communicate a clear five-year strategic plan defining financial and sustainability milestones.
Both McKinsey and Piccinino agree that there are other methods of offering guidance outside formal quantitative metrics. Companies should provide information that ‘can help the market to understand their business, the underlying value drivers, the expected business climate and their strategy – in short, to understand their long-term health as well as their short-term performance,’ noted the study.
Information such as this can help constrain analyst estimates as effectively as any quantitative guidance.
