Over the past two decades, the debate has been ongoing. To some it is a controversial topic, to many – a big headache.
It’s likely interesting for those of you who are not – ahem – as old as I am that the guidance debate seemed to start around the beginning of the millennium when Regulation FD (“Reg FD”) was enacted in the United States and the U.S. Congress protected companies from liability statements about projected performance. Prior to Reg FD, estimates were ‘managed' by companies with sell-side analysts in a way that could be, let’s just say, less than wholly transparent and fully disclosed to the entire market.
As more securities regulation came into the capital markets, issuers focused on remaining compliant, while providing some insight into the expected performance of their companies. We all know that when an issuer reports earnings and meets or beats market expectations on a sustained basis, it will get ‘paid’ for its performance in the form of a better multiple. And many corporates also feel that providing some form of guidance leads to improved investor communication and less volatility in the stock price.
That said, what is the general practice of corporate issuers in Canada?
A comprehensive survey conducted by CIRI entitled IR directions: Guidance Practices, 2014, showed that the overwhelming practice was to give some sort of guidance – both financial and non-financial. The practice varied in terms of quarterly, annual and longer-term outlooks, but the reason given was fairly consistent: to help establish reasonable market expectations and to improve transparency. Furthermore, over 80% of respondents indicated they did not foresee any change in their guidance practices.
For companies that did not provide guidance, the top two reasons cited were management philosophy and increased liability risk. These rationales were followed by the inability to predict performance, economic uncertainty and Board philosophy.
Over the past few years, several large and well respected asset managers have openly advocated for listed companies to focus on the long-term and stop issuing guidance. Articles and thought pieces outlining this view provide very cogent arguments.
So how does a given company decide which approach is best?
Among the benefits of providing some sort of guidance are:
- Instilling within the capital markets confidence in management’s ability to forecast and run its business;
- Delivering context for assumptions underlying the forecast; and
- Establishing a framework for discussing the company’s business, its expected performance and key metrics, without the fear of drifting ‘offside’ when speaking to the Street about the business.
The more obvious challenges of giving guidance include:
- Potentially encouraging ‘short-termism’ in expectations of both the company and investors; and
- Issues that arise when a company does not meet guidance – namely, hits to its credibility and multiple.
It seems to me that the debate about guidance tends to omit one very important consideration. It is difficult to help investors think about your business over the mid- to long-term without offering a framework for discussion.
Furthermore, many securities lawyers will advise issuers that even if the company has not issued any guidance, if that company expects to fall materially short of, or exceed, the Street’s expectations, it must provide an update to the market. Think about that for a second. Current securities regulations can be interpreted in a manner that would require an issuer to update the market about expectations that the company did not set. That, for me, is always a headscratcher; kind of a ‘damned if you do, damned if you don’t’ scenario.
In the midst of this debate, I find that issuers, the Street and regulators are focusing on the philosophical rather than the practical. That is, what should we do? What is best practice?
Today, most companies do not provide guidance specific to quarters, but they do offer outlooks on their business that are either annual or longer-term.
Companies tend to guide on things that really matter to the market and generally would be difficult for investors to discern for themselves.
Examples of this include energy companies providing details on their annual budgets with respect to capex, cash flow and ‘realized price’, or the price of oil they use to set their budgets. These are critical elements that an external investor cannot really assess.
Companies that are undergoing massive transformation or doing an acquisition need to, and in fact almost always do, help the Street comprehend the effects of the transformation, or how to assess the benefits of an acquisition.
Management of companies with income-oriented stocks generally provide long-term dividend increase targets. This is key since – while investors expect some capital appreciation from these stocks – the equities are valued based on the Street’s conviction that the companies will be able to steadily increase their dividends at the prescribed rates.
It might appear to readers of this article that I favour providing guidance. Actually, I do not have a ‘black and white’ point of view when it comes to this decision. In my opinion, each company must carefully reflect on a number of factors and, among other criteria, understand the pros and cons of its situation and determine whether it will be ‘rewarded’ by the market for providing guidance.
As investor relations officers, I believe we have an obligation – in truth, an imperative – to not just blindly do what others are doing. Each company is different, and there are many things that must be taken into account.
In fact, the reason this debate continues to rage is that there is no simple answer. Our job, as IROs, is to wrestle conscientiously with the question and help make the best choices for our companies.
Janet Craig is a senior investor relations executive with over two decades advising some of Canada’s largest companies during times of transformation and change.