What do investors want from guidance?
If there’s one thing the investment community agrees on in relation to guidance, it’s the fundamentals: it wants something realistic, reliable and tangible, something it can use to measure and judge your company. But when it comes down to the details – the how, when and why of guidance – opinions are divided.
For example, Chris Bailey, head of global direct investments at Close Brothers Asset Management, and Andrea Williams, European fund manager at Royal London Asset Management, both say guidance is basically always good for the share price. On the other hand, Martin Deboo, consumer goods analyst at Investec, isn’t convinced. And Michael Liang, chief investment officer at Hong Kong’s Foundation Asset Management, bridges opinion; for him it depends on the type of company and the industry you operate in.
Liang admits ‘you can’t work in a completely guidance-free zone’, but Deboo says guidance – especially an EPS forecast – is not what matters. He says ‘what’s good for the share price is a well-managed company with a clear strategy’, followed by execution of that strategy: ‘Ultimately that’s what drives the share price.’ Citing a recent McKinsey report, he argues that ‘consensus management and rigid earnings guidance don’t have much influence on share prices, despite what management thinks.’
But Bailey concedes there is demand for certainty, from both markets and investors; and this means a guidance policy is essentially beneficial, providing ‘at least something to aim for – something to indicate how a company sees its prospects evolving.’ But he adds that things can get messy when a company makes too many changes to its forecast, or even offers up too much information: ‘That’s what causes uncertainty and knee-jerk reactions, which ultimately is not good for developing a long-term shareholder base.’
Bailey believes EPS is important, but says companies shouldn’t get hung up on such a tight number. ‘Softer’ key performance indicators (KPIs), such as the ‘implementation of a cost-reduction plan, accessing new markets or introducing products in a timely manner’ should also be discussed because a ‘really well-managed firm’ can use KPIs as a yardstick, which in turn helps the share price.
Williams, who also ultimately feels that having a guidance policy – ideally including financials – is good for the share price, agrees: she wants something to ‘hang her hat on’ but she doesn’t want to be drowning in data. ‘There’s no point in giving a quarterly forecast because you’ll be all over the place in terms of moving it and changing the parameters in changing economic conditions.’ Even if you are giving quarterly forecasts, she advises sticking to just three or four significant elements investors can use to measure performance.
Assuming guidance is wanted and warranted, how often should companies provide it? ‘The danger of a quarterly guidance culture is that it encourages pursuit of short-term returns at the expense of the long term,’ explains Deboo. ‘The old classic was that you cut marketing expenditure in the fourth quarter to make your numbers, but that just cripples you for the next year.’
Deboo thinks companies should avoid not just quarterly guidance, but also quarterly reporting. This is because, he argues, it complicates what should be a simple question. ‘As there are around 90 trading days in a quarter, if you’re in a leap year you have an extra trading day in one of your quarters,’ he explains. ‘Straight away you’ve got to start warning everybody about that. You get into all these minutiae that are not relevant to the real question: is the company creating value?’
In China, where regulatory differences between mainland A-Shares and Hong Kong-listed firms mean some companies are required to give quarterly forecasts while others are not, Liang says there is no clear benefit to offering more regular forecasts. What he does want to have, however, is something more than a simple number. ‘What we want to understand is where that number comes from,’ he says.
It’s easy to fall into the trap of believing the market cares only about EPS, according to Bailey, but this tight focus can lead to even more confusion. ‘It’s remarkable how wrong [brokers] can be because they’re just looking at one number when perhaps a full range of indices might be a bit more insightful,’ he explains.
Deboo goes further. ‘Turning everything into an earnings equivalent makes the discussion very opaque,’ he says, noting that debate often focuses on inflation costs affecting guidance by something as little as two cents, ‘when really the better way to have that discussion is to ask: what’s that as an operating profit impact?’
The latest research from IR Magazine supports Bailey’s view. Where a rating of one is not at all accurate and four is very accurate, Thomson and Bloomberg – the two biggest firms compiling consensus earnings estimates – score just 2.7 and 2.6, respectively, perhaps explaining why some companies have begun assembling their own (see the Consensus earnings estimates report, after page 10).
The same report finds 40 percent of firms are now collating and distributing consensus estimates, with 86 percent using an in-house system. Deboo says he prefers to see a company’s collated consensus because ‘usually those numbers will have gone through a degree of ‘cleaning’ via the company’ – by which, he stresses, he doesn’t mean anything sinister.
‘The problem with Bloomberg estimates is that brokers use different definitions of profit – before tax, after tax, or whatever – so they get influenced by rogue outlying estimates,’ he explains. He takes the example of Unilever – which famously called time on earnings guidance in 2009 when Paul Polman took over as CEO – as an example of how to ‘clean up’ consensus. ‘The IR person at Unilever goes through all the forecasts, making sure everything is aligned in terms of definition and throws out the topmost and bottommost forecast so the maximum and minimum consensus are hopefully fairly sensible,’ he adds.
But this growing European trend comes with potential drawbacks, in Deboo’s view. ‘It could lead to a sort of consensus management culture where you’ll be informed by the firm, The deadline is due; please have all your estimates in. At worst you’ll get a call from somebody saying, You’re a bit out of line with consensus here – do you want to think about that? It could get rid of a lot of the diversity of opinion that should exist.’
But the fact that investors and analysts may not want to be inundated with facts, figures and commentary every three months doesn’t mean you should shy away from adjusting estimates if things change; nor should you try dropping guidance altogether simply because of a negative outlook.
‘I think the guiding principle is that a company has to be honest with the market,’ says Deboo. ‘If an outlook is negative, [the company] has to say so, and it has to give some indication of what’s driving the negative outlook.’
Liang adds that keeping quiet during difficult times won’t save your share price anyway. ‘[The company] will either take a hit when it gives the warning or take a hit when it announces the results. The magnitude of the share price correction could be very similar,’ he says, adding that if you warn the market, you will at least emerge with a better reputation.
In fact, the market will almost certainly have worked out that things might not be going so well, points out Bailey, who advises using as much candor as possible in such situations. ‘Frankly it’s unlikely to be ‘new’ news if a company says things are tough, things are poor or things are still bad,’ he says.
Offering a range rather than a tight number, as suggested by both Bailey and Williams, can help in such situations by allowing you to absorb performance fluctuations. ‘It’s always helpful if [companies] give a range,’ says Williams. ‘That way, they can let themselves off the hook if something goes awry. If they can say, We’ll be at the lower end of the range that’s not as bad as completely walking away from [a specific number].’
The market undoubtedly values consistency so cutting down on guidance might be assumed to do permanent damage to your share price. If done correctly, however, you can make it work. The key lies in letting the market know why you’re making these changes and in providing something – whether a long-term five-year plan or broad KPIs – that investors can use to gauge your performance.
Even Deboo, who advocates moving away from the financials, says you shouldn’t drop guidance altogether. ‘Analysts can’t operate without any guidance or dialogue whatsoever,’ he says. After all, no matter how much research is done from the outside, ultimately the company will have the best insight into its own performance.
‘If [a company is going to] stop giving guidance, it still has to have some strategic overview so you can see what it’s trying to achieve,’ says Williams. And Deboo notes that while Unilever might not provide guidance in its original form, it does offer a ‘high-level’ statement talking about how the company is looking to increase volume while protecting margin and cash flow.
The same principles essentially apply if you plan to offer forecasts for the first time. Offer up no more than five ‘tangible, measurable, realistic’ KPIs over a long enough period of time for the market to have confidence you can deliver on your claims, suggests Williams.
Quality, not quantity
In the end, Deboo says the investment community will make up its own mind. He advises firms to focus on qualitative forecasts rather than US-style quantitative guidance – an idea backed by the UK’s IR Society – and ‘give the market the component parts. But don’t try to guide it to a number.’
Clearly the kind of guidance you give depends on the type of company you run. Williams highlights the regulatory issues creating uncertainty for many banks, by way of example, but essentially the guiding principles remain the same whether you want to stop giving guidance, offer forecasts for the first time, or simply change the way you guide the market.
‘Nothing is black and white,’ says Liang. ‘Providing guidance is necessary for some companies but not for others because they have much longer business horizons, or perhaps their business is highly unpredictable and giving reliable guidance is very difficult. In the end, the key to all the guidance and KPIs is that investors need transparency and integrity in the numbers you report.’