Managing Wall Street expectations is one of the trickiest challenges for CEOs and CFOs. After all, analysts and investors are fickle; sentiment can change on a dime…or a quarterly earnings conference call.
So with another earnings season approaching, executives may want to think about managing Wall Street expectations. Messaging is particularly important during results season because that is when stock volatility – both leading up to the reporting date and immediately after – tends to be highest.
One strategy companies should consider is to stop giving quarterly guidance. Executives have been wrangling over this issue since an influential McKinsey study in 2006 suggested that the perceived benefits of providing guidance were, well, misguided. Since then, others have weighed in on the pros and cons of doing so.
As a former long-time technology analyst turned adviser to companies on investor messaging, I side with the cons. Providing quarterly guidance no longer serves its originally intended purpose.
Why do CEOs and CFOs Succumb to this Pressure?
The pressure to meet the quarterly demands of Wall Street can be unrelenting. It can compel executives to make misguided decisions on resource allocations, undermining innovation, go-to-market initiatives, customer satisfaction and loyalty, and employee engagement, recruiting and retention. It can also lead to financial engineering – and in extreme cases – outright fraud, exposing the company to SEC actions and lawsuits.
The question should be, “Why do executives feel the need to give quarterly guidance?” No company manages its business from one quarter to the next. And providing low-ball quarterly guidance that management believes it can comfortably meet or exceed only feeds the monster in this game.
One study conducted five years ago concluded that the shares of companies that do give quarterly guidance are less volatile than their peer group. However, I would argue that this study is outdated. That’s because over the past decade, quantitative (algorithmic) and passive investing (indexing) has doubled to 60% share of average daily stock trading volume. Also since then, investments in Exchange-Traded Funds (ETFs) – both passive and active – have more than doubled.
The upshot of this is that today, shares of companies that do not give quarterly guidance are no more or less volatile that their peers. They are also not penalized with lower relative valuations or less analyst coverage.
What about Longer-Term Guidance?
If executives want to get investors to appreciate – if not think – longer-term about their business they should consider giving annual guidance as an alternative. In most companies, strategic plans have 3-5 year horizons; more likely at the lower end of that range for technology companies. Management likely reassesses them annually, and makes tweaks quarterly. This is certainly the case in the technology sector, where rapid change and shorter product cycles are the norm.
On quarterly conference calls, executives can make nuanced comments about how they are performing relative to full-year guidance. This is where messaging matters. But not just during quarterly calls. Regular outreach to shareholders and analysts, coupled with appearances at conferences and hosting their own analyst/investor day, can help companies build better understanding of their business while managing Wall Street expectations more effectively.
If you miss consensus expectations, the sky will not fall. Your share price will. It may even fall a lot. But it’s unlikely to fall more than if you had missed quarterly guidance – had you provided any. The knee-jerk reaction is to sell first and ask questions later. And since half the reason why the stock falls is because forward quarter guidance is below current analyst estimates, why expose yourself to a double-whammy?
Among tech companies I have worked with, the few that had the courage and resolve to give only annual guidance have not suffered disproportionately. In fact, several outperformed their peer group. If you’re guiding toward the longer-term, then you can always recover.
Value for Customers Drives Value for Investors
In my experience, the single most important thing a company can do is invest and innovate to help customers succeed. If the management team has a sound vision, a strategy to fulfill that vision and clearly articulated plans against which it executes, it generally creates value for its customers – and its shareholders.
One way companies can ensure that they invest and innovate for the long term is to compensate their teams accordingly – and communicate with Wall Street about the hows and whys behind their plans. Key performance indicators, or KPIs, of the business (i.e. revenue growth, market share, margins, cash flow, etc.) are the metrics that drive compensation.
Execute on these and the share price will follow.