Companies that play guidance game must address misses, too

The other day, a midsize company reported earnings that were significantly higher than the year-ago quarter, as well as several other positive operating metrics.

The other day, a midsize company reported earnings that were significantly higher than the year-ago quarter, as well as several other positive operating metrics.

Though the outlook for the rest of 2006 was revised downward slightly, the new outlook was still much higher than 2005's performance. In the press release, the company's CEO painted a rosy picture for the future and was nothing less than upbeat in tone. The stock slumped 25% that day, probably its worst single-day performance ever.

What happened? Did some external news event undermine the company's solid numbers and optimistic tone? No, but the company presented its quarterly earnings as though they were in a vacuum, ignoring that the results, while certainly positive from a year earlier, were also 25% below analysts' expectations. Not surprisingly, the year-ago numbers were now considered ancient history. In other words, the company entered an ongoing conversation without paying sufficient attention to what others were saying, and it paid a heavy price - at least in the short term.

While the argument continues as to whether companies should play the earnings guidance game or stay mum, a company that does give guidance can't then make believe that expectations don't exist, and, therefore, a company has little choice but to address those expectations.

The company, in its press release and investor conference call, needn't focus solely on analysts' expectations, but it's in management's best interest to spend a moment or two discussing the miss, if only because that's what just about every investor is focused on.

Publicly traded companies inherently don't operate in a vacuum. Investors, analysts, reporters, vendors, and employees are constantly talking and, in a sense, are always in a conversation. When a company enters the conversation through, for instance, a press release, but doesn't acknowledge the current state of the ongoing conversation, it has created a disconnect and potentially damaged its credibility.

To hope that no one will recognize the miss or to pretend that the miss doesn't matter because the company is not beholden to analysts' expectations creates a dangerous gulf with investors over expectations that the company helped set.

Now there is the practical question: If the company had been more forthcoming or direct about the miss from analysts' expectations, would the stock price have been less savaged by investors? Probably not, though there is no hard evidence one way or the other. But one thing that is almost certain is that the company's credibility was unnecessarily undermined, and now time and energy will have to be devoted toward regaining trust from stakeholders.

At the same time, pre-announcing is not necessarily a better route. Often, a company knows little more than that it won't make its numbers. While that may be all some investors want to know, many investors - especially those in for the long haul - want an understanding of why expectations were not met and what the company plans to do to boost its performance.

Simply stated: There are no blank slates in public markets.

Fred Bratman is president of Hyde Park Financial Communications.

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