Why do public companies declare their results? Is it purely for investors to know the results? Not entirely. The focus of analysts and investors is often more on the earnings guidance of the company. So, what is earnings guidance? To understand earnings guidance, the first aspect that an investor must know is that this is different from earnings announcements.
An earnings announcement is different from earnings guidance in that the former is a statement of facts whereas the latter is a futuristic view or the company’s outlook. Earnings guidance is a future projection of the growth that a company intends to achieve in the top line and bottom line.
What is earnings guidance?
An earnings guidance is a set of information offered by the management of a public limited company. It contains data on the company’s expected future results, revenue estimates, expense forecasts, earnings, margins, etc. Through earnings guidance, the company’s management communicates its future direction by establishing short-and long-term goals.
How is earnings guidance important and how to interpret it?
Not all companies offer earnings guidance. For instance, in the Indian IT space, Infosys and Wipro are known to provide earnings guidance regularly. However, TCS mostly provides only analysis and not guidance on earnings. Here are the top reasons why earnings guidance is important:
a. Price or volume growth
Earnings guidance gives an insight into the future top-line growth. Top-line growth is mainly to do with the revenue growth of a company. Earnings guidance helps in understanding whether the revenue growth is expected to come from volume growth or from pricing related growth. If an earnings guidance shows higher revenues through pricing, it indicates the pricing power of the company. Such trends are mostly seen in sectors such as cement and FMCG. Volume growth is an indication of increased width and depth of the market.
b. Margin guidance
One can also find margin guidance as part of the earnings guidance of a company. This gives a futuristic perspective as far as the profitability of the company’s operations in the near future is concerned. This is an important metric since the valuation of any company is mostly determined by its earnings. It also provides a view of how the company’s stock price could move in the coming year.
c. Guide for analysts
Earnings guidance is an additional reference point for analysts while making earnings projections. While most analysts rely on quarterly earnings for future projections, an earnings guidance can further assist in directing specific questions to the company’s management. It is an important guide for analysts to fine-tune their projections with regard to the company performance. With earnings guidance, analysts can offer their views on the company stock and further categorise it as overweight or underweight.
d. Future investment decisions
Earnings guidance also helps institutional investors, like mutual funds and insurance companies, to determine the management’s projection of the company’s growth in the near future. With earnings guidance, institutional investors can get a view on whether to hold the position or switch to better alternatives.
How to interpret earnings guidance provided by a company?
To interpret earnings guidance provided by a company, an investor must focus on the company’s track record and measure its past performance against the guidance. This will help in giving a clear idea of how the company will deliver compared to its past performance. This also gives an insight into the future perspective on the company’s stock performance.
Earnings guidance has become an integral part of the earnings announcement in many established markets such as the USA. Investors are starting to place more importance on the earnings guidance as they gain insights into the expected stock price movements to make informed future decisions on their investment.
How does earnings guidance influence investor decisions?
Earnings guidance can influence stock ratings that are given by analysts. This can have a significant and direct impact on investors, especially when it comes to sell, hold, or buy decisions with regards to stocks.
For example, if a company’s management shares earnings guidance that is not as per the market expectations, analysts may lower the rating of the company’s stock and the investors may decide to give up on their stock position basis this rating.
Important factors to note while using an earnings guidance
Earnings guidance may sometimes contain incorrect information and can end up adversely impacting the company’s growth since investors may choose to exit the stock holdings to avoid future losses. Unless substantiated using the company’s past performance data, earnings guidance may by itself not suffice for investment decisions.
Seasoned and HNI investors are known to be requesting companies to avoid handing out earnings guidance as it can lead to companies over-emphasizing generating earnings as per projections while ignoring other long-term objectives pertaining to growth and expansion.
Earnings guidance should be used cautiously by investors and analysts since it can give a mixed picture of the company’s outlook if used by itself. Ideally, it should be used as a reference in conjunction with the other data sets on the company’s performance to get a clear outlook while making an investment decision.
Most companies offer earnings guidance as part of its quarterly and annual reports shared with investors, analysts, and shareholders.
Investors often look at factors such as a company’s earnings growth, relative strength, debt-to-equity ratio, price-to-earnings ratio, dividend payouts, etc while deciding on the right stocks to invest.
Most investors rely on fundamental and technical analysis to predict if a stock price will go up or down. Additionally, investors may also use the company’s earnings guidance to predict stock prices.
The four commonly used investment strategies include value investing, growth investing, momentum investing, and rupee-cost averaging.
Public limited companies are required to report their earnings through quarterly and annual reports in every fiscal year.