We are well into earnings season now.
We write a lot about earnings at InvestorPlace.com. We write about the results, but our goal is to help people understand and make decisions about stocks. You can find the earnings results anywhere, so we strive to help people understand what the numbers mean.
We write articles such as, “Is Company X a Buy After Earnings,” and “What to Look for as Company Y Reports Earnings Tomorrow.”
And as I review reports about revenue and profitability, I always end up asking myself the same question.
Do I believe the guidance?
For those who don’t know, in financial reporting guidance is a publicly traded company’s official prediction of its own near-term prospects. How it believes the company will perform in both the near-term and long-term.
Exactly how relevant is any prediction about future growth given the negative sentiment that seems to dominate news?
Most people acknowledge that companies use guidance to game the system.
I’m not accusing everyone, but some will sandbag the numbers. CEOs will use guidance to temper expectations so that their company can beat analyst’s estimates when earnings are released in the next quarter.
Despite knowing that, most companies that announce higher than consensus estimates or previous guidance typically get a stock price bump.
And they should get that bump. After all, that’s management saying, “Wall Street, we’re going to do better than you say.”
Since investors know companies try to walk down expectations, any positive guidance is seen as a sign of management confidence. No company would set themselves up to fail, so positive guidance is a sign that the next quarter’s earnings will at least meet those expectations.
That leads to advice like, “Ignore the sandbagged guidance and buy X on future growth” and “despite conservative guidance, stock Y is too cheap to ignore.”
Certainly missing your estimates can be very costly.
The uncertainty in the markets has made this a particularly bad quarter to miss your estimates. Bloomberg published an analysis Tuesday showing that missing sales or profits estimates this quarter has been particularly costly.
Among the companies that have released earnings so far, those that missed on income but beat on revenue have declined 4.3 percent in the three days after reporting earnings. That’s almost four times more than the 15-year average, according to Dennis Debusschere, head of portfolio strategy at Evercore ISI. Those that missed on both the top and bottom lines slid 5.2 percent, compared with a multiyear average of a 2.7 percent loss.
Companies that beat on sales and earnings rose 1.9 percent in the three days after reporting the results, according to Evercore ISI, a few points shy of the 2.1 percent average. In other words, those that miss on sales and earnings are going down almost three times as much as those that beat are going up.
This week, we also saw how positive guidance can make a big difference in stock price right away.
IBM announced quarterly earnings on Tuesday. The company beat Wall Street estimates on both sales and earnings, but that doesn’t explain the largest single-day stock gain the company had in years.
The story was the guidance.
IBM has fallen behind the rest of the cloud computing world. The company has tried to transition its business to catch up, emphasizing the cloud, data analytics and security. The company’s recent acquisition of Red Hat offered a chance to accelerate the change.
For the quarter, IBM reported adjusted earnings of $4.87 per share, beating Wall Street expectations. More importantly, the profit and cash flow guidance for fiscal year 2019 exceeded the current analyst view.
“In 2018 we repositioned our business model and delivered revenue, operating profit and EPS growth along with strong free cash flow realization,” CFO James Kavanaugh said in a prepared statement.
Guidance for non-GAAP EPS in 2019 of $13.90 compared with $13.81 in 2018 is not particularly exciting, but it was above Wall Street analyst expectations of $13.79. And if you believe that a company wouldn’t set itself up for failure, this was management signaling growth even better than that.
For a company that hasn’t generated any growth recently, this statement was seen by many as a signal that the company has finally turned a corner.
InvestorPlace contributor Dana Blankenhorn noted that the company seems to have finally developed a strategy that makes sense.
Red Hat has given IBM a path toward profitable growth, and IBM has spent the last quarter creating a suite of products and services it can deliver around Red Hat’s hybrid cloud solution.
IBM stock has long been among the cheapest tech shares out there, but only because it wasn’t growing. If it can grow, the stock becomes a real bargain, and the fourth quarter results indicate it can indeed grow.
The fourth quarter of 2018 transformed IBM stock from a sell to a buy.
The stock jumped finished the day up more than 8%.
Plenty of Wall Street heavyweights are critical of providing any future guidance at all.
In an op-ed in The Wall Street Journal last June, Warren Buffet and Jaime Dimon wrote that quarterly guidance encourages “short-termism” and is harmful to the economy. They argue that the system forces CEOs to focus too much attention on making the next quarter’s number, and not focus on long-term growth that is better for the company. Although they were clear to state their support for quarterly reporting of financial performance, they believe statements about future guidance are not helpful.
Clear communication of a company’s strategic goals—along with metrics that can be evaluated over time—will always be critical to shareholders. But this information, which may include nonfinancial operational performance, should be provided on a timeline deemed appropriate for the needs of each specific company and its investors, whether annual or otherwise.
Later in the summer, even President Trump jumped on this bandwagon, tweeting out that he had asked the SEC to investigate whether to eliminate quarterly reporting.
Some argue that reporting every six months wouldn’t necessarily decrease volatility. They argue that six-month reporting would still lead to the short term thinking many object to, and would reduce the information available to investors about the financial status of the companies they own.
So far, the SEC has not acted on President Trump’s suggestion and certainly won’t be making any progress in that direction during the current government shutdown.
Neil George, editor of Profitable Investing thinks moving away from quarterly reporting is a bad idea.
Guidance of course is used for evil. Management has agendas that are different than for shareholders. If they can goose expectations – they can get spin in the market to bolster stock prices. Or in the recent case with Apple, the guidance is more about covering their backsides for the coming quarterly report.
And of course, when it comes to the quarterlies – every companies’ management wants to beat estimates so they massage what they can in analyst’s calls.
Whether done month by month or quarter by quarter – the information on sales and costs as well as balance sheet developments is always helpful for investors. Sure, some traders will use the information to buy or sell for the short-term which Buffett and Dimon complained about as it could influence self-centered managers to focus on the quarter rather than the years to come.
But good management gives out as much information as possible without compromising business development (sales or supplier contracts) and at the same time, provides the appropriate views on how the company is planning to proceed over the longer haul. Good investors and good newsletter writers take short-term information to build up the case to buy and own or to sell and move on.
That’s the key point.
Good management provides as much information as possible AND provides the appropriate views for the long haul.
When you are evaluating earnings performance, you’re evaluating how the company performed against previous guidance. If the company regularly meet or exceeds its guidance, you can have more confidence that it will do so again in the future.
And we are all looking for stock guidance we can trust.
Louis Navellier has a free tool to help with this that I really like. His Portfolio Grader tool focuses on fundamentals such as earnings growth, earnings momentum and earnings surprises when grading whether a stock on an A-to-F basis.
Simply type in a stock ticker and you can see how Louis ranks it on eight separate factors. You can access the free tool here.
Louis also provides weekly updates to subscribers of his Growth Investor service, as well as model portfolios, and regular advice about when to buy stocks you probably haven’t considered.
For my money, I believe most individuals investors would benefit from the type of guidance provided by Louis in his Growth Investor service and Neil in his Profitable Investing service. Those two smart analysts, and their teams, work tirelessly to interpret all the reporting and guidance to give investors a fair view of which companies are living up to their obligations…and which are blowing smoke.
As always, we are just an email away firstname.lastname@example.org.
How much weight to you give guidance? Do you compare earnings reports to past guidance, and how much does a quarterly miss affect your perceptions of a company?
To a richer life…
Luis Hernandez, Managing Editor
and the research team at InvestorPlace.com