Recently NYU professor and author Baruch Lev penned an article in the Wall Street Journal on the perennial subject of earning guidance, arguing that when done “smartly” guidance can benefit investors, companies and management alike.
Professor Lev is of the school of thought that guidance contributes to better overall market data, reduces uncertainty, share price volatility and litigation risk and that it can increase analyst coverage and management credibility.
However, the trend over the last several years has been that of companies moving away from issuing quarterly earnings guidance, many instead offering annualized guidance or non-financial guidance of a general nature, and still others electing to suspend or all together discontinue guidance.
On the other side of the debate, those critical of the practice of issuing earnings guidance argue that preparation and delivery of guidance is a drain on management’s time and a company’s resources, that guidance encourages short-termism and that it distorts incentives.
But in his article Professor Lev dismisses many of these criticisms, and offers up a few tips on the “right … ways to do guidance,” including to: “guide when you are a better prognosticator than analysts … if most of your industry peers release guidance regularly … when uncertainty about your company’s prospects are high … [and] when forthcoming earnings will disappoint … .” Professor Lev also argues that guidance “should be part of a wider strategy of regularly disclosing fundamental information about [your] company and its business model … .”
Whether or not to provide guidance and, if you do, the type of guidance to provide, is a company specific choice, one that should be made by management together with the audit committee, and in some cases the entire board of directors. But let’s assume for a moment that you’re in agreement with Professor Lev and that your company has decided to provide guidance, what then should you consider when developing (or revisiting and updating) your guidance policy?
What Kind of Guidance Will You Provide?
One of the first things to address is what kind of guidance to provide. There are any number of metrics for you to choose from, both quantitative and qualitative. For example, many companies provide guidance on factors like revenues, net income, margins and of course earnings per share, as well as on non-GAAP measures* like adjusted net income, adjusted EBIT or EBITA and adjusted earnings per share.
The myriad of possibilities notwithstanding, you should only provide guidance in metrics that you feel you can accurately forecast. Additionally, once you’ve selected an appropriate set of metrics, you need to consider whether you are best suited to offer guidance in terms of a single number (e.g., “we expect earnings of $9.30 a share on sales of $37 billion”), in a range of numbers (e.g., “we expect net income to be between $144 million and $150 million”) or as a percentage (e.g., “we expect our adjusted EBIT margin to increase to around 13% and adjusted earnings per share by about 10%”).
Guidance can also come in the form of non-financial metrics, such as guidance about market conditions, trends in your industry or your long-term vision and strategy. Non-financial guidance can take just about any form you can think of (e.g., “we plan to open approximately 100 new stores” or “we anticipate market conditions to remain challenging due to the economic environment”) and can be useful in adding context to a forecast.
How Often Will You Provide Guidance?
Closely related to the matter of form is the question of how often to provide guidance, with most companies doing so on an annual or quarterly basis, and occasionally on a selective basis in between periods. The appropriate interval is again a company specific choice. It depends in part on internal considerations, like the resources that you’re willing to devote to the preparation of guidance and the interval at which you feel you can accurately forecast in the metrics you’ve chosen, and to a certain extent on external considerations, like the norms in your industry.
For example, if you’re a regulated utility you can likely forecast earning per share on a quarterly basis with less effort and more accuracy than say an airline carrier or a bank holding company can. In addition, if a majority of companies in the utility industry, or even just a majority of your peers, provide quarterly earnings per share guidance you should factor that into your own analysis of whether to provide similar guidance.
How Will You Present Your Guidance?
Whenever you present guidance it must be delivered in a manner that is compliant with both the requirements of the federal securities laws, the anti-fraud provisions and Regulation FD in particular, and the disclosure and reporting requirements of the exchange on which your securities are listed. Accordingly, most companies that provide guidance do so as part of their annual or quarterly earnings calls, with many still making guidance a part of their earnings release (as was required of NYSE listed companies prior to May 2009).
Still you can provide guidance at just about any other time, but doing so at odd intervals or in between periods requires a bit of careful planning. Let’s say, for example, that you decide to provide additional guidance in between your regularly scheduled quarterly earnings calls. Best practices for written guidance might include the issuance of a press release or a written statement coupled with a Form 8-K filing. Similarly, best practices for oral guidance might include the prior issuance of a press release or a written statement coupled a Form 8-K filing, which either sets forth the guidance to be presented orally or announces your intention to provide oral guidance by a means readily accessible to the general public, such as on a conference call or in a webcast. What’s more, whenever presenting oral guidance you have to be mindful that you only address forward-looking information. Any discussion of or updates regarding material non-public information from a previously completed fiscal period will trigger additional disclosure requirements under Item 2.02 of Form 8-K.
In addition, regardless of how you choose to present your guidance, it should always be preceded by an appropriately fashioned cautionary statement on forward-looking information, one that is up-to-date and addresses material risks specifically related to the guidance. Any presentation should also set forth the key assumptions on which your guidance is based and note that actual results may differ from projections.
What’s In Your Guidance Policy?
In the end, you should put it all together in a written guidance policy, whether a stand alone policy or as part of your overall disclosure policies. Your guidance policy should at least sets forth when and how you will provide guidance and whether you will update previously issued guidance. Your guidance policy should also be amended any time your practices change and everyone responsible for providing guidance should be familiar with its terms.
*Remember that if you provide guidance in a non-GAAP financial measure you also have to comply with the requirements of Regulation G.