Best Buy announced on March 30 that it “no longer expects to provide a specific forecast for quarterly earnings per share.” The Richfield-based company said in its Form 8-K filed with the Securities and Exchange Commission that the decision was “consistent with management’s focus on long-term revenue and earnings growth.”
In making that choice, Best Buy was a joiner, not a trendsetter. The legacy practice of providing quarterly earnings guidance is being challenged by a growing number of companies. Many say they can better serve investors by concentrating on and talking about the fundamentals of their business, rather than setting and measuring themselves against three-month goals.
In April, the National Investor Relations Institute in Virginia, reported on its members’ earnings-guidance practices. Among 654 companies surveyed, those who give quarterly earnings guidance decreased from 61 percent last year to 52 percent this year, while those giving only annual guidance increased from 28 percent to 43 percent.
But is less frequent earnings guidance in the best interest of shareholders? To answer that question requires examining two others: 1) Does the practice of giving guidance contribute to volatility in a stock’s price? 2) Does it have an impact on a company’s long-term market value?
Many on Wall Street fixate on quarterly earnings expectations and the speculation over whether a company will meet those expectations. Exceeding or missing a projected earnings figure by as little as one or two cents per share can cause big moves in a stock’s price—as happened to Best Buy last winter; its share price fell 12 percent when third-quarter earnings were just two cents short of expectations. Hedge funds, in particular, trade on swings in investor psychology surrounding earnings estimates and reports, and sometimes cause dramatic surges or declines in the market when they sell stocks long or short.
On the other hand, some argue, when companies don’t give earnings guidance, they leave themselves open to more diverse earnings expectations, which can also be a source of stock-price volatility.
And what about long-term value and guidance practices? Against those who say that a company builds credibility by consistently setting and meeting earnings targets are others who argue that a quarterly snapshot only distracts from the big picture of growth rates, competitive issues, income statement trends, and capital structure that are the primary determinates of value.
The trend line away from quarterly guidance is clear, but controversy will continue to surround guidance decisions. That’s because there is no one right answer to the question of what serves investors best when it comes to earnings guidance. The considerations are different for large companies with plenty of analyst following than for small ones that don’t get the same attention; for mature companies than for new ones; and from industry to industry.
It’s no surprise, then, that conversations with local investment managers and public-company executives on this subject yielded no consensus. But they were illuminating nonetheless, shedding light on what any company must consider when choosing its earning-guidance practices.
All market capitalization figures are from June 15, 2006.
