When analysts and corporate managers each provide guidance with respect to quarterly earnings, the result is a recipe for the most accurate forecasts.
An entire profession is built around the business of trying to predict correctly corporate earnings for the next quarter and for the coming years. And yet, as a new study from our researchers and AlphaNow, entitled How Good is Guidance, suggests, it is only by combining the fruits of analysts’ research efforts with earnings guidance from the companies themselves that investors will be able to obtain the most accurate estimates possible.
Initially, the study shows, companies do the best job at estimating future earnings per share. But once they make those predictions, analysts add value by refining and modifying their own forecasts, ending up with a figure that is closer to the actual earnings than was that company forecast.
Unsurprisingly, when companies publish their own guidance and when they report quarterly earnings, this affects not only their share prices but also market expectations. Regardless of whether the guidance has been positive or negative in the weeks leading up to the earnings announcement, investors appear to expect that the company will deliver a positive surprise. Companies whose executives manage to offer the most accurate guidance in combination with that provided by analysts however, appear to be the best served in terms of what happens to the stock price. When actual results are in line with the company’s forecast, and when the company hasn’t steered analysts’ expectations higher or lower, the market reaction is muted. In contrast, guiding expectations higher or lower, while it can increase the impact of a positive surprise on a company’s share price, can be a risky strategy. Trying to set a low hurdle may lead to a big earnings surprise when results are announced – but the stock price gain companies achieve then is likely to simply reverse the hit the stock took when the company steered guidance lower in the first place, for instance.
It is intriguing to note that those companies that guide analysts’ estimates higher ended up with the greatest rate of accuracy in terms of those analyst forecasts. That suggests that analysts find it more surprising for companies to issue such “positive” guidance than to provide warnings about headwinds taking shape or simply reassurance that analysts have generally gotten their forecasts right.
For more insight into the methodology, and more details on these and other findings of the report, please click here.
