Risk & Compliance

Kicking the Guidance Habit

Frustrated, CFOs who still provide EPS forecasts eagerly await the tipping point that will spell the death of quarterly guidance.
Sarah JohnsonApril 10, 2007

When it became fashionable for CFOs to provide investors with quarterly earnings guidance in the mid-1990s, they may not have realized that the practice would become habit forming. By the time finance chiefs grew weary of coming up with predictions every three months—and explaining why their companies missed previous forecasts—investors and analysts had come to expect the report. As a result, it hasn’t been easy for companies to wean Wall Street and shareholders off of earnings-per-share forecasts.

Still, many CFOs did quit the quarterly grind, including those at Coca-Cola, McDonald’s, and Pfizer, who announced the change earlier this decade. But for every story of a company foregoing quarterly guidance, there has been another company fearing that stopping the practice would sound alarm bells for investors and result in a tumbling stock price. “You’re stuck in a Catch-22,” says Jules Fisher, CFO of medical device maker Possis Medical, who continues to issue the guidance. “You’re damned if you do and damned if you don’t.”

Since Regulation Fair Disclosure (Reg FD) took effect in 2000, finance executives have had to be more careful about how they share material information publicly. To be sure, Reg FD requires widespread dissemination of material nonpublic information. That kind of regulatory pressure, combined with a desire to focus more on long-term strategy, has turned many CFOs against giving quarterly earnings guidance.

In fact, more than 60 percent of the 73 CFOs polled in a recent Financial Executives International survey said that they believe public companies should stop providing quarterly earnings guidance. Instead, that group favors providing a range of EPS predictions once a year.

The FEI survey was prompted by a recent U.S. Chamber of Commerce report that called for all U.S. public companies to stop giving quarterly forecasts. The Chamber hopes to incite “a stampede” of companies that will cease to issue EPS guidance, so the stoppage becomes widely acceptable, says David Hirschmann, a Chamber senior vice president. “Quarterly earnings guidance has outlived its usefulness.”

Companies began privately sharing their earnings forecasts with large investors in the 1970s. By 1995, when Congress passed the Private Securities Litigation Reform Act, which protects companies from liability when stating projected performance, the practice of issuing public, quarterly guidance became more common. Before the surge abated earlier this decade, more than one-quarter of the 4,000 companies that generate at least $500 million in revenues annually provided earnings guidance at least once, noted a McKinsey & Co. study. Today, at least half of all public companies continue to issue quarterly earnings guidance, according to the National Investor Relations Institute’s (NIRI) most recent research on the subject.

While CFOs haven’t been shy about privately telling select business and research groups that they’d like to ditch the practice, they have been more skittish about telling shareholders and analysts that they’d like to make a change. Furthermore, finance chiefs who still issue quarterly guidance say that they are unlikely to stop.

That’s because besides risking that the news will cause investor jitters (some observers argue that a stock price drop is a short-term risk), companies that halt guidance could be forcing investors to rely too heavily on analysts’ predictions. “People’s expectations could get significantly out of sync with where the company really thinks the results could come in,” Fisher told CFO.com. As a result, finance executives who don’t provide guidance may still feel obliged to react to targets posted by outside analysts.

Companies need to figure out how to deal with predictions that they can’t control, says Michael Umana, senior vice president and CFO of LoJack Corp., the maker of vehicle antitheft devices. LoJack provides only annual guidance that includes growth percentages for net income and EPS. But at least seven outside analysts continue to theorize about how much the company will make each quarter.

LoJack is not alone in changing reporting benchmarks. According to NIRI, 43 percent of public companies provide yearly guidance, with many of them replacing EPS forecasts with other types of performance predictors to satisfy data-hungry investors. It’s a practice that has worked for Progressive Insurance, which releases monthly reports on key operating statistics. “Ironically [Progressive Insurance] actually provide more information more frequently and [the information is a] higher quality,” explains Dean Krehmeyer, executive director of the Business Roundtable Institute for Corporate Ethics, which released a report on earnings guidance last year.

In addition, consider Walter Industries. The coal producer and exporter stopped providing quarterly and annual EPS guidance last year, but still gives investors plenty of information on a quarterly basis, including what CFO Joseph Troy calls “topline drivers,” such as cost estimates for each ton of coal the company extracts. “As you long as you provide enough information about value drivers, I don’t think investors care about EPS estimates,” Troy told CFO.com.

In the past, says Troy, his team was spending too much time developing forecasts “down to the Nth degree,” and they’d have to play catch-up during the quarter if something unexpected happened. That’s been a similar complaint at other companies, Krehmeyer notes. Quarterly EPS guidance can be “very narrow, oftentimes just to the penny. It can be so narrow in range that a lot people ignore the complexities of businesses operating in a global environment over the next 90 days,” he says.

Some CFOs don’t have to deal with investors who are used to quarterly guidance. Jack Sennott, senior vice president and CFO of Darwin Professional Underwriters, never began the practice. Darwin is only four years old and went public just last year. “We really want investors to look at the merits of how we’re doing as a company and not where we are versus expectations,” he told CFO.com.

For CFOs who want to eliminate quarterly EPS guidance, but are not as fortunate as Sennott, he recommends making a “clean break” with investors by being up front with them. “Use an investor conference call to explain to them and analysts that [quarterly earnings guidance] has encouraged you to focus on the wrong areas,” suggests Sennott.