To Guide or Not to Guide: That is the Question (Part 2)

Posted by on July 10th, 2013

In my Part 1 discussion of issuing guidance, I briefly touched on providing quarterly vs. annual guidance and the visibility of your revenue stream.  Now I’d like to discuss the three other topics brought up in Part 1: Point vs. Range Guidance, Financial Measures and Non-Financial Measures.

Point Guidance vs. Range Guidance

In case the title isn’t clear, this debate is whether or not to issue specific point guidance [i.e. $100 million in revenues and $0.20 earnings per share (“EPS”)] or to issue a guidance range (i.e. $100-$110 million in revenues and $0.20-$0.24 EPS).  While I have seen both used in practice and I haven’t read any materials that suggest there is preference for one or the other, I think providing a guidance range is more practical for micro- and small-cap companies, but point guidance is more practical for mid-mega cap companies.

For management of small-cap companies, this allows some wiggle room in case a contract doesn’t come through on time or there are slightly stronger revenues than anticipated.  For investors and analysts, it allows them to get a strong sense of where the company believes they are headed for the guided period, yet doesn’t tie them down to one specific number that everyone is focused on.  As for larger companies, they should have a firmer sense of what their numbers will look like for the period and should be able to identify a specific point guidance.  Additionally, for a multi-billion dollar company, the difference in a few million dollars is not as significant as it is for a small-cap company, thus allowing them to pick a specific (large) point and come in around this number.

It should go without saying that issuing a guidance range becomes useless if the range is too big.  Each company needs to determine how closely they can predict their earnings for the guided period and determine a range that satisfies their goals and analyst/investor expectations.

Financial Measures

Now that you’ve decided to issue your quarterly or annual guidance, the next question to answer is what metrics will you be providing?  For this, I’ll turn to some research I dug up on the issue, as it will do a better job of answering this question than me.

Excerpt taken from “Corporate Finance Alert” by Skadden, Arps, Slate, Meagher & Flom LLP

“The types of guidance companies issue can vary widely. Although companies typically provide guidance on earnings per share, some companies give only revenue guidance. Many companies also provide projections regarding adjusted net income or adjusted EBITDA. Often, these adjusted measures of operating performance may be easier to predict since they are unaffected by many of the income statement items that affect earnings per share. Some guidance may focus on other operating data. For longer-term guidance, companies may provide more subjective goals and forecasts. The type of guidance companies provide depends on the type of company, the industry and comparable guidance provided by its peers, and on the particular facts and circumstances of each individual company.

Current market conditions, where earnings are less predictable and it is harder to forecast accurately, may support a move away from earnings per share and other similar guidance toward guidance focused on other measures, such as long-term performance, key developments, strategy and risks. Under those circumstances, investors can benefit from increased information and enhanced transparency without the complexities and issues associated with forecasting earnings and operating a business with the short-term goal of meeting those estimates.”

Non-Financial Measures

In the appropriate industry (i.e. coal or other commodities), it may be more prudent to provide guidance as it relates to the market as a whole.  Since you may have no control over the price of the commodity as it is determined by the open market, relating your guidance to the market will allow investors to track your progress relative to the market or industry.  While this certainly leaves room for interpretation in terms of company performance, it may be the only practical way to provide followers of the company an appropriate guidance target.

Other non-financial measures to consider are (dependent on the industry): significant contracts signed, new sites or facilities coming online, number of subscribers, etc.

So, all-in-all, I support the practice of providing guidance and believe what type of guidance companies provide should be heavily dependent on their business model and industry they operate in.  To summarize, I saw a relevant quote from Jeffrey Morgan, President and Chief Executive Officer of NIRI, which was published in a press release dated May 28, 2008 titled “NIRI and CFA Institute Centre Release Results of Joint Study on Public Company Guidance Practices and Preferences.” While it’s a little dated and deals with the broader ‘disclosure’ issue, I think it still holds true:

“Public companies generally provide a wealth of information to assist investors in better understanding their operations, of which guidance is just one piece.  These results reveal that there is a demand for various types of guidance, and that NIRI members are meeting that demand in the way best suited to their unique circumstances. The survey results also support the concept that there is no ‘one size fits all’ form of disclosure, and that each company needs to consider its internal forecasting abilities, the needs of the financial community, all other constituencies and industry practice, all in the context of stock exchange and federal and state disclosure rules and regulations, when formulating an effective disclosure policy.”