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The fallacy — and cost — of giving quarterly earnings guidance

Many executives believe that the quarterly game of giving Wall Street “earnings guidance” provides various benefits: visibility, reduced stock volatility, better valuations. But thorough research by McKinsey & Co. indicates that the practice doesn’t actually work — there’s no evidence that it produces the expected benefits — but carries its own costs.

The two costs:

  • It takes up valuable management time to prepare the guidance reports (i.e., it’s a distraction).
  • The practice produces too much emphasis on short-term performance.

In my opinion, that short-term mindset gets in the way of long-term strategic thinking and thwarts important investments in areas such as innovation, human capital, environmental sustainability, safety, and competitive intelligence. This short-term mentality — called “short-termism” — could be the No.1 problem in American business.

Oh, and McKinsey’s researchers found that, when some companies stopped providing the quarterly guidance, there were no dire consequences.

The conclusions of McKinsey’s study:

[T]o maintain good communications with analysts and investors, companies that currently provide quarterly earnings guidance should shift their focus away from short-term performance and toward the drivers of long-term company health as well as their expectations of future business conditions and their long-range goals. Companies that don’t currently issue guidance should avoid the temptation to start providing it and instead focus on disclosures about business fundamentals and long-range goals.

The current trend — more and more companies discontinuing quarterly guidance and substituting thoughtful disclosures about their long-range strategy and business fundamentals — is a healthy one. In this way, companies will better signal their commitment to creating long-term, sustainable shareholder value and encourage their investors to adopt a similar outlook.

————
Source: “The misguided practice of earnings guidance,” by Peggy Hsieh, Timothy Koller and S. R. Rajan, originally published in McKinsey on Finance (March 2006)

Related:
Should CEOs of Public Companies Offer Earnings Guidance?
Companies Consider Ending Quarterly Earnings Guidance (.pdf)
Breaking the Short-Term Cycle (.pdf)
 
Weighing the pros & cons of earnings guidance 
Opposition Builds to Earnings Guidance
Investors want to end earnings guidance 
Time to Deal With ‘Short-Termism’

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2 thoughts on “The fallacy — and cost — of giving quarterly earnings guidance

  1. Pingback: Wall Street analysts still hyping their stock picks « Corporate Intelligence

  2. Pingback: Most companies fail at forecasting earnings « Corporate Intelligence

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