Why Companies SHOULD Offer Earnings Guidance

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Why Companies SHOULD Offer Earnings Guidance

Recently Jamie Dimon was interviewed by Bloomberg, and commented that companies should stop giving earnings guidance. This is out of character for me, but I will explain why companies should offer earnings guidance. (Why is it out of character? Previously I have said that I don’t personally care whether firms that I own give earnings guidance or not… that still remains true.)

From the interview:

JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said corporate leaders shouldn’t give earnings guidance because they can’t predict the future and should focus instead on long-term performance.

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Some CEOs “start making promises they shouldn’t make,” Dimon, 59, said Monday in a Bloomberg Television interview with Stephanie Ruhle. “Don’t make earnings forecasts. You don’t know what’s going to happen every quarter. I don’t even care about quarterly earnings.”

 

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While many JPMorgan shareholders “completely appreciate” long-term investing, other market participants overreact to short-term results, Dimon said. The New York-based firm last week reported third-quarter profit that missed analysts’ estimates as a slump in trading and mortgage banking drove revenue lower from a year earlier.

Dimon is mostly right, as far as he goes, particularly when you think about a complex bank, where the accounting for profits over a short period is less than an exact science.

I’ve written at least two articles on earnings estimates:

In general, I think you have to have something like [adjusted non-GAAP (ANG)] earnings estimates in order for shareholders to have some measure of how corporations are tracking in their goals of building value. That doesn’t mean that corporations have to facilitate that, because the sell side will do it themselves if the company is big enough, the shares trade enough, or it raises capital often enough.

Dimon and other CEOs can sit back and let the earnings estimates be their own little sideshow. Still, there is a reason to give forward guidance. It lowers your cost of capital on average.

Forward guidance gives investors (and sell side analysts comfort that there is a business model there that is predictable in building value. I’m not talking about GAAP earnings, but ANG earnings because in principle they should reflect the true increase in the per share value of the firm after eliminating accounting entries that distort that effort.

Now don’t get me wrong. Not all companies craft their ANG earnings so honestly — they may even adjust differently period to period to make things look good. As with all things in the market, buyer beware.

But if companies can show that they have adequate control over their financial results such that they forecast future earnings and they honestly come to pass, investors will think the place is better managed than most, and reward it with a higher P/E multiple.

That is my simple argument.

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

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