Should Management Guidance Be Eliminated?

I'm an Armenian-American. That means that I scan the scrolling list of credits after a movie for Armenian names. It means my ears perked up to learn that Principal Skinner on The Simpsons is Armenian. And it also means that when I see a financial article written by a fellow Armenian, I'm rather likely to read it. That's why I found myself reading a Vahan Janjigian piece from Forbes.com the other day, on "Why Eliminating Guidance Is a Big Mistake."

Let me back up, though, and define terms. In case you weren't aware, Wall Street analysts and company management don't keep to themselves. Analysts should be studying their assigned companies and coming up with their estimates of the companies' future numbers and intrinsic values. But they often do this with the help of management, because most company bigwigs like to tell the world what to expect in the coming quarters or years.

For example, the management of Bed Bath & Beyond (Nasdaq: BBBY  ) said in its latest quarterly conference call with analysts that the company is aiming to have more than 1,300 domestic Bed Bath & Beyond stores in the near future, which reflects a goal of 60% growth in the U.S. Then there's Parametric Technology (Nasdaq: PMTC  ) , which reported recently that its expected sales level in the coming quarter and year will be below previous estimates, because of falling license revenues in the U.S. and Japan. And BlackBerry maker Research in Motion (Nasdaq: RIMM  ) recently upped its estimates for its coming second quarter to between $1.37 and $1.49 per share, on sales of between $1.30 billion and $1.37 billion.

All that kind of information gets factored into many analysts' estimates, which in turn inform investors' opinions and decisions regarding many companies.

Pros and cons
So is this a good thing? Well, yes and no, if you ask me. On the one hand, who knows a company most intimately, and who's in the best position to offer educated opinions on how it will fare in the future? Its management. It seems silly to ask them to keep their mouths shut.

On the other hand, what motivates management? Many times, keeping the share price rising is a paramount concern. And a share price can be influenced via guidance from management. Imagine, for example, that the CEO of Home Surgery Kits (ticker: OUCHH) expects his company to take in $1 billion in 2007. If he announces that he expects revenues of $900 million and then the company reports $950 million, the company will look good for having beaten expectations.

Janjigian offered other thoughts. For starters, he pointed out that the Securities & Exchange Commission requires companies to report their financial results on a quarterly basis. Thus, while some criticize managements for offering quarterly outlooks that create an unhealthy focus on short-term results, it's the SEC requirement that gets investors to focus on the short term.

He then suggested that without company guidance, estimates from analysts would become less accurate, creating larger surprises when earnings are released. He concludes by asking, "In an era in which regulators are trying to promote more disclosure, how much sense does it really make to tell corporations to stop providing guidance?"

He also pointed out, rightly, that while some object to the volatility resulting from companies missing or beating expectations, that volatility can present very useful and profitable entry points for bargain-hunters.

What to do
So what should we make of all this? Well, let's live with the reality of management guidance, but with an informed perspective. Don't take every number at face value. Know that it's routine for companies to be off the mark -- after all, it's impossible to really know exactly what the future holds.

In the meantime, you can get more perspective from these articles:

And if you'd rather leave all this analysis to trained professionals, consider investing in some top-notch mutual funds, ones with proven managers and appealing track records. You can find them on your own, by reading broadly or screening for them. I also invite you to sign up for a free trial of our Motley Fool Champion Funds newsletter, which offers terrific fund recommendations monthly in an easy-to-digest format. (I've found a bunch of winners there.) Its picks are beating the market by some 15 percentage points, and last time I checked, none of them were underwater. In fact, over just a few years, fully 25 of them are up more than 40%. A free trial will give you full access to all past issues, so you can read about each recommendation in detail.

Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article. Bed Bath & Beyond is a Motley Fool Inside Value recommendation and a Stock Advisor pick. Try any one of our investing services free for 30 days. The Motley Fool is Fools writing for Fools .


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