Last week, Jamie Dimon and Warren Buffett dropped an interesting nugget in a joint interview on CNBC, calling for an end to quarterly earnings guidance that, in their view, brings an “unhealthy focus” on short-term profits vs. long-term business success.
Dimon and Buffett are both legends in the investment business with well-earned reputations, and they raise an important philosophical discussion. But facts are facts: Over the past three-year and five-year periods, companies that offer guidance have generally performed better than those that don’t.
It is true that in some cases, quarterly guidance is at best unhelpful and at worst misleading. Many companies may have an excellent view of the near future, thanks to subscription-based contracts, predictable conversion of a large backlog, or the ability to lock in supply costs or end-market prices. But other companies may have far less visibility into the next quarter or year. It’s also true that some companies play a “beat and raise” game with their guidance, managing expectations deftly in an effort to generate positive investor sentiment. As always, buyers should indeed beware of the reliability and motivations of their data sources.
When we looked at the data, we found that companies in the S&P 500® Index that offer guidance are in the minority. Only about 20% provide quarterly earnings guidance, and even fewer (15%) provide quarterly revenue guidance. And these companies have definitively outperformed the rest. And as seen in the chart, the numbers are clear: The median three-year annualized return for companies offering earnings guidance was 14%, vs. 7% for those that don’t. Over five years, the difference is even more striking—15% vs. 9%. And the companies offering revenue guidance offered shareholders a whopping 18% annualized return over both three- and five-year periods. (All return figures are as of June 8, 2018.)
Source: Factset®. As of June 8, 2018.
Three-year and five-year periods don’t let us judge a company over multiple business cycles, but they are a big enough window for a company to establish a track record of business performance. Companies can launch new products, develop and execute strategies, and tackle new markets within these timeframes. In other words, five years extends beyond what we would call a short-term period.
These facts would seem to suggest that investors should pounce on all companies that provide guidance. But as an investment strategy, that would be equally as dangerous as deciding to avoid all companies that provide guidance. The truth, as always, is somewhere in the middle. There are many potential reasons why companies offering guidance have performed well. These companies often have confidence in their business strategies and good visibility into the future, and thus they are more comfortable projecting their results. Of course, we can’t ignore the fact that many of these companies are in growth sectors like technology and health care, and those segments of the market have generally performed well in the last few years.
Most importantly, we think that the decision to invest or not invest—and we are confident that Mr. Dimon and Mr. Buffett would agree—should be based on a fundamental evaluation of each company’s business strategy, and NOT on whether they have chosen to share guidance about that strategy with the market.
The views expressed are those of Brown Advisory as of the date referenced and are subject to change at any time based on market or other conditions. These views are not intended to be and should not be relied upon as investment advice and are not intended to be a forecast of future events or a guarantee of future results. Past performance is not a guarantee of future performance and you may not get back the amount invested.
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