Why Do Companies Issue Guidance?

By Sean Ryan, CFA

“Guidance” is the term used for forecasts about future earnings by a company’s management. Many companies issue guidance to analysts and investors, sometimes just for the current quarter, sometimes looking out a year or more.

The reason companies do this is to reduce uncertainty about earnings. As a general rule, markets don’t like surprises and companies that are predictable and don’t surprise the market often have higher stock prices as a result.

Not all companies offer guidance. Some managements view the effort as a waste of their time, while others are fearful of providing fodder for lawsuits of their guidance turns out to be incorrect.

Guidance takes different forms at different companies. Guidance is generally informal, and there is no standard format. Some companies offer very detailed guidance about revenues, expenses, and other financial measures, while others just offer guidance on earnings per share. Some companies’ guidance takes the form of a very wide range (“We expect earnings to grow by between 10% and 30% next year>”) while others are very specific (“We anticipate earnings per share in the range of $1.03 to $1.05.”).

Guidance, of course, is just that. It isn’t legally binding and plenty of unforeseen events can occur to make guidance turn out to have been wrong. But it gives investors a sense of what management’s expectations are based on current trends.

Guidance isn’t binding on analysts or investors, either. It reflects managements’ expectations, and so an analyst who thinks that things will be better or worse than management does may publish estimates that are significantly higher (or lower) than company guidance.

As with most financial information, guidance is just one part of the mosaic, and should be treated with the same skepticism as other claims and predictions by managements.

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