Commentary: With Earnings Guidance, Silence Is Golden
By Nanette Byrnes
Last December, when Coca-Cola Co. stopped giving out earnings estimates, it looked like something of a maverick. Only a handful of companies had abandoned the ritual hint-dropping to Wall Street on where quarterly earnings were headed. Those companies, including Warren E. Buffett's Berkshire Hathaway, Barry Diller's USA Interactive, and insurer Progressive, had long refused to hand out earnings guidance. Coke, on the other hand, was proud of its record of meeting Wall Street's predicted numbers. To abandon the quarterly earnings game was a 180-degree turn.
Coke wasn't lonely for long, however. In recent months, a dozen major corporations have followed suit. Some, such as McDonald's Corp. and AT&T, have such skittish prospects that predicting earnings truly is a challenge. But others, including Mattel Inc. and PepsiCo Inc., have taken the same step for the opposite reason: They're in good shape and figure this gives them a chance to walk away from the world of whisper numbers and CNBC-addicted day traders. Pepsi, in fact, made its announcement in February after reporting its 13th straight quarter of 13%-or-greater earnings growth.
With the recent spate of business scandals, it might seem like a step backward for companies to stop answering the most basic of business questions: How much money do you think you'll make? Critics worry that a lack of guidance could lead to more earnings surprises, greater stock volatility, or even less vigorous oversight of management.
In fact, it's a great leap forward. Successful strategies are not executed in three-month time slots. By refusing to play the quarterly guessing game, companies reduce the focus on short-term performance. That lessens incentives for accounting shenanigans aimed only at juicing the numbers. And investors benefit when companies, in lieu of earnings guidance, disclose data that can help shareholders dope out the company's prospects for themselves. "If the market broadly adopted [no guidance], I think substantive performance by organizations would be rewarded, not short-term decisions that make a quarter look better," says John J. Brennan, CEO of Vanguard Group Inc., the mutual-fund giant.
Executives who spurn earnings guidance say they can refocus managers on more important goals. PepsiCo CEO Steven Reinemund told analysts that guidance was "taking up too much time [and] is too precise." He now talks about broader long-term goals. Likewise, in property- casualty insurance, one disaster can wipe out quarterly earnings. CEO Glenn M. Renwick of Progressive Corp. now releases monthly premium volumes and ratios of underwriting profitability. He says these are better measures of corporate discipline than earnings forecasts. The extra data helped reduce stock volatility by giving investors a clearer picture of performance.
Such changes will force Wall Street analysts to delve more deeply into the companies they cover. That's all to the good. Amy P. Hutton, an associate professor at Dartmouth College's Amos Tuck School of Business, notes that even though analysts found Enron Corp.'s business model bewildering, they had a stellar track record at predicting its earnings -- before its implosion -- thanks to the company's "guidance." For 16 quarters in a row, Wall Street's estimates were within pennies of the actual number. "The problem with that," says Hutton, "is it left investors with the impression that the company was predictable."
Enron wasn't the only company spoon-feeding analysts. A study by Hutton found that, in the third quarter of 2000, 44% of guided earnings came in at 0 cents to 3 cents per share above consensus estimates -- to give Wall Street a pleasant surprise. But such precision isn't earnings guidance. It's earnings management.
Byrnes covers accounting issues from New York.