Many publicly traded corporations periodically release statements about how they think they will do in the coming months. These statements, which typically come out every quarter, are known as earnings guidance. Wall Street pays close attention to these statements, which are not legally required, but there is no consensus on how guidance actually affects the market. Here is an overview of what to make of these statements.
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What Is Earnings Guidance?
Earnings guidance, sometimes known as “forward-looking statements,” is a company issuing information about how it expects to do in the months ahead. An earnings guidance will generally contain information about estimated revenue, expenses, losses, profits, debts, earnings and any other information relevant to the performance of the business.
The point of an earnings guidance is to improve communications with both shareholders and the investor market at large. They are intended to let investors understand what the company sees about its performance and how it expects that performance to continue in the near- and mid-term.
Companies that issue guidance generally do so on a quarterly basis, around the same time that they issue earnings reports. However, this is not a legally required document. The federal government does not mandate that publicly traded companies issue guidance on operating income or similar metrics, and as a result they can do so on any schedule they see fit. Many choose not to do so at all.
In addition to statistical information, many companies will include a strategy discussion in their earnings guidance. Typically this will discuss goals and issues that the business will address in the coming months.
Uses of an Earnings Guidance
Investors can take many pieces of information from an earnings guidance. It can tell you how the company plans to act. If there is a particular challenge that it has faced, the company may tell investors how it plans to address this. It may also discuss business strategy in the light of market-wide or macroeconomic conditions.
For example, companies affected by rising tariffs or falling energy costs might include their responsive business plans in their earnings guidance.
A guidance also contains the company’s financial forecasts. It lets you know how the company sees its earnings and liabilities in the coming months and gives you the chance to decide if you agree with the firm’s assessments.
Ultimately, this is perhaps the most useful information an investor can take from an earnings guidance: Do you agree with the company’s judgment?
An earnings guidance is a subjective document. The company cannot lie to investors about past or present information, but all forward-looking data is considered a projection. As an investor you have no assurances that the company will actually meet those goals, or that its liabilities or other concerns will resolve as predicted. The company might assume a favorable interest environment, only for rates to raise. It might not anticipate significant liabilities that could turn a profitable quarter upside down. These are all the risks inherent to an earnings guidance.
As a result, the key question is whether you feel like the company has a sound approach to its business plan. Do you think those numbers look good, or do they seem overly optimistic? Do you think it can achieve its near-term goals?
Companies don’t just use an earnings guidance to communicate information. This is media material. In most cases the company uses this as a chance to bolster its position in the market, usually by making sure to tell everyone just how well the firm is doing. However, it may also release soft numbers specifically so it can outperform its own projections. That’s not the same thing as lying, but it’s important to remember that this is a voluntary document. Companies aren’t likely to release information that will tank their stock price “sua sponte” or voluntarily.
This makes an earnings guidance a complicated document. If all else fails, though, treat it as a fundamentally optimistic report, a best-case scenario. Now evaluate what you think of the company’s judgment. Do you think their optimism is warranted, and would you like to continue doing business with a firm that anticipates these numbers?
A Skeptic’s View of Earnings Guidance
Whether it’s a good idea for companies to issue earnings guidance is an open question. A 2006 article published by the global consulting firm McKinsey takes a dim view of the practice:
Most companies view the quarterly ritual of issuing earnings guidance as a necessary, if sometimes onerous, part of investor relations. The benefits, they hope, are improved communications with financial markets, lower share price volatility, and higher valuations. At the least, companies expect frequent earnings guidance to boost their stock’s liquidity.
We believe that they are misguided. Our analysis of the perceived benefits of issuing frequent earnings guidance found no evidence that it affects valuation multiples, improves shareholder returns, or reduces share price volatility. The only significant effect we observed is an increase in trading volumes when companies start issuing guidance.”
In other words, an intention to issue guidance with a view to getting a share price bump is unlikely to be realized.
Where to Find an Earnings Guidance
Companies will release an earnings guidance through several possible channels. This can include, but is not limited to:
- Investor, public or press release. The company may issue the earnings guidance as an independent document issued to investors, the market at large or even the media.
- Quarterly reports. The company may include an earnings guidance as part of its required quarterly financial reports.
- Earnings call. The company may hold an earnings call. This is a large-scale conference call which generally involves investors, analysts, the media and any other interested parties. Many companies which hold earnings calls do so quarterly.
Bottom Line
An earnings guidance is a statement of how the company believes it will do going forward. It generally includes financial statements and business goals, but it’s important to understand that the document involves projections, not commitments.
Tips on Using Earnings Guidance
- An experienced financial advisor will consider earnings guidance alongside numerous other methods of analysis when choosing investments for your portfolio. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Any financial statement worth reading will discuss the P/E Ratio, among other key indicators. These “fundamental” statistics about a company’s financial health and outlook are considered when performing fundamental analysis of a stock.
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