If the head of the US Chamber of Commerce had his way, CEOs would immediately stop providing quarterly earnings guidance.
In urging companies to stop playing the numbers game, Donahue was jumping on a bandwagon that already includes such large companies as Coca Cola, Sun Microsystems and AT&T. In fact, according to an industry study more than 50% of US-listed companies no longer offer such guidance, compared to about 35% two years ago. Even the sage of Omaha, Warren Buffet, opposes providing quarterly guidance.
Does anything more need to be said?
You bet. Especially for companies outside the Fortune 500.
As Donahue himself points out, two-thirds of NASDAQ companies are covered by only one or no analyst. Smaller companies simply lack the proven track record of blue chip companies that can comfortably avoid the numbers game. Without research analysts to provide guidance, as they do for larger companies, investors in companies with smaller market caps need the reassurance that company quarterly estimates provide.
The fact is that earnings guidance is the senior management's report card. Every 90 days a company's senior management, no different than a student or salesman, accounts for their performance. Investors get to see how close senior management is to the day-to-day running of a company.
Critics of earnings guidance, such as Donahue, say that a company's stock gets unfairly hammered if it misses its quarterly number by even a penny. But that's generally not the reason investors vote with their feet. More often the company has also released other bad news, most likely that future performance looks less than promising. Investors focus more ? or even exclusively ? on the future. They care where your stock price will be in three months, six months or next year. Today is ancient history.
What's more, companies can generally avoid the missed penny headache, if they offer guidance within a reasonable range. Investors seek reassurance that senior management has its finger on the company's pulse.
But don't companies get penalized for missing their number by events out of their control, such as Hurricane Katrina? Again, the dip in a stock price because of a natural disaster or terrorism is more attributable to the consequences such an event will have on the company's future performance, not on the past quarter. And of course, that can work both ways. Companies that stand to benefit from reconstruction or homeland security will likely see gains.
And then there is the argument that companies will short change long-term R&D just to make its number, and, as a result, lose their competitive edge to China or other emerging countries. While there are surely some CEOs who might play this game, the ones who have clearly laid out their plans and then stay the course usually inspire investor confidence and demonstrate that they know what they're doing and where they're going.
Capitalism is inherently messy, and Donahue is right that politicians in Washington acted in haste when enacting Sarbanes-Oxley, which puts an unnecessary and costly burden on smaller companies. But eliminating earnings guidance will hinder the dynamism of the marketplace. Without quarterly guidance, investors are more likely to shy away from smaller companies and instead stick to the safer blue chips. In this case, the solution is worse than the problem.
Fred Bratman is president of Hyde Park Financial Communications. He can be reached at email@example.com.