By CFO Brew Staff
less than 3 min read
Definition:
Earnings guidance, or the information public companies share concerning their projected future revenue, profits, and other metrics, is usually delivered during earnings season, typically in a public company’s quarterly earnings release and its earnings call.
Investors use these projections—provided as a specific number or a range—to get a sense of how well management expects the company to perform in future quarters. Analysts use it to plug into their models for valuing the company’s shares. If a company issues weak financial guidance, well, that’s typically not looked upon favorably, especially if they lower a prior forecast.
Sure, if you love astrology, you could check your horoscope. But if you’re a real astrology fiend, you could always just look at earnings guidance. It’s a bit like reading the stars. No, there’s no Scorpio rising and Libra moon, but there is fun stuff like projected net sales. If you’re a CFO and you have the guts to issue such targets publicly, you’d better know what you’re getting into.
Why does it matter? We’ve seen it happen time and time again: A solid earnings report, positive signs of upward momentum, but then, like when the wrong shoes ruin the whole outfit…dun dun duuunn…there’s less-than-ideal guidance.
We don’t need to tell you what happens after: The stock may plummet. (Most of the time. Usually.)
What if you’re wrong? While earnings guidance can impact share prices and cause equity analysts to revise their stock ratings, earnings guidance is protected under certain laws, like the Private Securities Litigation Reform Act of 1995, so that companies aren’t unfairly punished should projections fail to pan out.
Notably, public companies aren’t required to provide guidance. And even those that regularly do might occasionally opt out, as many public companies did at the start of the Covid-19 pandemic. (Beware, though: If investors and analysts have come to expect regular earnings forecasts, you’ll have to give them a good reason for why you stopped.)
Critics of earnings guidance argue that the practice puts too much emphasis on short-term thinking, while advocates appreciate that guidance is beneficial thanks to the information it provides investors when making decisions.
What else? If your company issues guidance publicly, you put the pressure on the organization to hit a very specific range of numbers—which, however rigorously generated, could be off.
According to a 2022 study by a professor at the University of Iowa’s Tippie College of Business, “many [managers] seriously overestimate their ability to issue accurate earnings guidance.”