MARKET FOCUS : Sitting on prophets

Coke has started a trend on Wall Street by no longer forecasting its earnings.

Coke has started a trend on Wall Street by no longer forecasting its earnings.

Coca-Cola popped off a trend in the investor relations space in late 2002 that still appears to be fizzing as Wall Street heads into the spring. In December, Coca-Cola surprised the Street by announcing it was abandoning the practice of providing investors and analysts with so-called "earnings guidance." In essence, that meant the beverage giant was putting a halt to making any public estimates about its short-term profits. In the past (like much of corporate America), Coca-Cola had provided the investment community with a relatively narrow range of earnings estimates on a quarterly basis. Such estimates have served as important short-term benchmarks in the minds of many investors, and have been instrumental in helping brokerage analysts devise their own widely disseminated earnings estimates. So the fact that a giant of corporate America was suddenly abandoning a staple of IR programs surprised many, not least the media, which had highlighted Coca-Cola's consistent ability to meet its guidance with remarkable precision in recent years. Long-term focus Perhaps most surprising was the reason for the shift: Coca-Cola said it was abandoning guidance so it could stop worrying about the Street's short-term expectations, and instead run its business for the long-term, which is, according to CFO Gary Fayard, "good for our shareholders." In short, Coca-Cola chalked up its decision out of its impatience with Wall Street's impatience. Several other well-known companies followed suit, including Mattel, McDonald's, PepsiCo, and AT&T. Yet while some have been quick to embrace Coca-Cola's high-minded rhetoric, others say they were motivated by a more pragmatic rationale. "We've learned over the last two years that we are not very good at predictions," said Matt Paull, McDonald's CFO, shortly after the decision was announced. "Certainly for 2003, we've decided to get out of the predicting business." Indeed, the protracted bear market and an economy that has been growing in marginal fits and starts in recent years has made forecasting difficult. Therefore, staking management and IR credibility on such forecasts has become a perilous exercise, say experts. Even some companies that are not abandoning guidance completely are "suspending" it because the near-term demand for products and services is hard to gauge. There is also a feeling that the retreat from guidance may be a lagging effect of Regulation Fair Disclosure (Reg FD) coming to the fore. Before Reg FD, companies would often set profit expectations solely through the brokerage analyst community by using analysts as a conduit to investors. Analysts' comments on future earnings were understood by savvy investors to be at least in part spoon-fed to them by management. The brokerage analyst was a tool to set and temper expectations. "In the past, if your earnings picture was altered mid-quarter, you could call your analysts and say, 'Some of our assumptions have changed,'" says Howard Zar, EVP of investor relations at Porter Novelli. "That would start a whole chain of questions and answers between the analyst and the IRO that would inevitably lead to the analyst lowering his estimates and thereby alerting Wall Street to the new expectation." Now that Reg FD forbids IROs from huddling up with analysts behind closed doors to help shape and tweak forecasts, companies have been forced to take public ownership of all their estimates. Experts say that this was less problematic during the bull market because most of the forecasts were strong and trending upward. But in the current economic malaise, companies find themselves in a tight spot. Amy Hutton, associate professor at Dartmouth's Tuck School of Management, has written extensively on the subject of earnings guidance, and feels other companies should follow Coca-Cola's lead. "What you're seeing is that when push comes to shove, many in management don't want to take ownership of forecasts - especially not in this environment. That's largely because, despite what people are told, forecasting is a very difficult thing, and businesses are risky and unpredictable," she explains. But most IR people say that abandoning guidance is not a viable option for most small and even midsize companies, which do not have the widespread recognition of Coca-Cola. Perhaps the biggest concern they cite is that many of these small companies risk losing their so-called "coverage" by brokerage analysts. When an analyst "covers" a stock, it means that he tracks the firm's financial performance for his firm's clients, and places an investment rating on the shares (these ratings are typically variations on "buy," "sell," and "hold"). Even though the brokerage analyst community's reputation has been hit by several scandals in the last year and a half, analysts still have an important role in the IR mix. And for many small and midsize companies, brokerage coverage is an important part in raising their profile on the Street. "Companies are afraid that if they stop providing guidance, they will lose coverage," says Lou Thompson, CEO of the National Investor Relations Institute (NIRI). "The feeling is that this places one more obstacle in the way of analysts when many companies are losing coverage as it is." Indeed, the analyst ranks have been shrinking recently due largely to brokerage-house layoffs. The difficulty some smaller companies are encountering in getting research coverage has led some to take desperate measures. Recently, The Wall Street Journal published an article detailing how some companies are even beginning to pay firms to publish independent research on them. Estimate, or be estimated Some IR veterans contend that walking away from guidance as a way of ending Wall Street's short-term focus is a false choice. They say that other short-term benchmarks will remain, most notably in the form of the earnings estimates that brokerage analysts will continue to publish, with or without the help of company guidance. The media, and outside vendors such as Thomson Financial's Thomson/First Call unit, gather these estimates and average them into what has become known as the "consensus" estimate. This estimate has largely become the short-term benchmark on which the Street is focused. Indeed, when a company's results miss the consensus estimate, its shares are often punished. This process has become a source of ire for many market watchers. "First of all, it's an average, not a consensus. And the fact that it took on this Holy Grail status is not the way things should be," says NIRI's Thompson. But others say its benchmark role is a fact of life on the Street, and that abandoning guidance forfeits both the chance companies have to influence this number and the range of analysts' estimates that produce it. "That number will be out there regardless of whether you're giving guidance or not," says Eric Leeds, MD of IR firm GA Kraut & Co. "Whether or not management comes out and takes responsibility for that consensus estimate, investors will still hold them accountable for it. Working on Wall Street, you learn really quickly that to most investors there is no such thing as the 'long term.' To them, the long term is basically just a series of short terms strung together." Leeds and others say that by refusing to give the Street any guidance, a company could end up with a more volatile stock price. They say analysts will be forced to derive estimates on their own, leading to a wider range of forecasts and a much foggier picture for investors. Others say that line of reasoning misses the point, and actually does a disservice to shareholders. "My research has shown that companies that give guidance do in fact have more accurate analyst forecasts," says Hutton. "But they were also more biased and significantly more pessimistic. In other words, these estimates were much more likely to be below the actual results. This is because management would try to do their best to talk down estimates so they could be surpassing the expectation. While people seem to think that wide range of estimates is somehow bad and does a disservice to investors, it actually just represents more information. And I think we can agree that the more information, the better." ----- Earnings guidance is still the norm - for now According to a recent survey conducted by NIRI of its membership, an overwhelming 77.5% of respondent say their companies provide earnings guidance, while only 22.2% do not. And of those firms that do not provide guidance, 71% offer investors other trend information that may impact business. "If you're not providing earnings guidance, you probably should be providing other trend information," says Gregory Pettit, financial relations director at Hill & Knowlton. The survey also offered evidence that any move away from guidance has happened only in the last year - 22% of the companies not providing guidance have stopped the practice within the last 12 months. Most companies that provide guidance say their preferred method of doing so is via quarterly conferences calls (89.6%) and quarterly news releases (78%). The NIRI survey also found that 54.2% of companies say they will issue a new release if "circumstances cause the guidance to change materially."

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