How Long-Term Investors Should Look at Guidance

With the mountains of analysis, expertise, and other noise coming out of the financial markets, it can be hard to know what numbers to pay attention to. So when a company shares guidance, that seems as if it should be important.

But there's management and analyst guidance, doled out quarterly or yearly, and every earnings season is abuzz with raised guidance, lowered guidance, guidance expectations, etc. ad nauseam. For newer investors, it can be hard to differentiate the good information from the bad.

In this clip from the Motley Fool Money radio show, Chris Hill, Matt Argersinger, Jason Moser, and Ron Gross explain how guidance is calculated, why investors should probably just focus on annual numbers, and why so much analyst guidance is, more or less, meaningless, especially for long-term investors.

A transcript follows the video.

This podcast was recorded on May 6, 2016. 

Chris Hill: I want to talk for a minute, just a minute, about company guidance, because we reference this all the time. It is always part of the story when it's earnings season. But I want to know how you guys use this as stock analysts. Matty, I'll start with you.

Matt Argersinger: I do take management guidance pretty seriously. I think when management sets expectations for the year, or beyond that, it's a way for me to gauge what I think the growth of the company could be, and it gives me ways to determine whether management is able to control the destiny of the company, whether they're able to reach goals. What I don't take very seriously, of course, is Street guidance you get from analysts --

Ron Gross: Other than us.

Argersinger: Well, yes.

Argersinger: Unfortunately, a lot of companies are very good at playing the earnings expectations management game. They're great at under-promising and over-delivering on quarterly earnings calls. For me, I don't know what the actual statistics are, but I feel like every time I read an earnings release, and you see the reaction, it's always, "This company beat by $0.02 or $0.03, or they beat revenue expectations by $10 million." It's no longer a surprise. What is surprising is that the stock still reacts positively in general to that, when it's really just all about a company managing expectations.

Hill: Ron, let's take a new company. If you start digging into a company and you buy the stock, is that management on a tighter leash than a company that you've known for a while, and a management team you've known for a while? I'm assuming it takes a little while to get a sense of how they are when it comes to offering guidance and their vision for the near- and long-term future.

Gross: That's fair. Some companies and some management teams are better than others at issuing guidance. And some industries lend themselves to guidance better -- early-stage technology, fast-growing companies, it's very hard to nail that, even if you're there every day managing the business. More stable, blue chip-type companies, you can kind of nail that management guidance. You can make it much tighter and not have to make as many revisions as you would with a high-tech company.

I think, if you're focusing on valuations and value, for example, like I do, it is helpful to get management's thoughts on where a company will be a year from now, in terms of cash flow and profits. The quarterly guidance is a little too much for me; it's a little too granular. They constantly have to update it. I would be fine if they just stuck with one year out. How does this year look like it'll shape up? That helps me to inform my models and make a decision about a stock.

Hill: Are you the same way, Jason? If you could wave a magic wand and then companies wouldn't give quarterly guidance anymore, would you wave it?

Jason Moser: Yeah, I wouldn't have a problem with that. I tend to always pay attention to what management says they're going to do. I care more about what management says they're going to do versus what any Wall Street analyst ever imagines they might be able to do. It always makes me chuckle, businesses like TripAdvisor, for example, where they don't really offer any guidance other than maybe a range of sales growth that they're looking at. But we know very well that management there is geared toward three- and five-year timelines there. So it makes me chuckle, the audacity of Wall Street, to sit there every quarter and say, "Oh, they missed analyst estimates by this much money!" Well, those estimates are just arbitrary guesses on your part. 

So, yeah, to Ron's point, some companies lend themselves better than others to setting guidance. But for me, the important part is that management is doing what they say they're going to do. If that's happening, and you see the business continuing to perform fundamentally well, over time, the stock market will recognize those good businesses. It's just a matter of us being more patient.

Argersinger: We have to remember, earnings-per-share numbers, which are, of course, usually the most prominent part of the earnings release, it's what analysts usually zero in on with whether or not a company missed, or what they're guiding for in terms of EPS, those numbers can be so manipulated -- I don't want to get in the weeds here, but the bottom line is those numbers can be manipulated in a way that, really, most companies, especially financial companies, or companies that have the ability to do that, can really report almost any number they want, in terms of earnings per share. So just be very aware of that.

Moser: Something as simple as share buybacks, for example, they always tout that as being such a great thing. Plenty of statistics out there to prove that companies are pretty bad at it. But that's one very simple way they can reduce that share count, and therefore boost earnings per share. Hey, that looks great for the quarter, you beat the estimates and everything -- but really, is that a sign that your business is performing?

Gross: And I'll just wrap it up by saying, if you're a long-term buy-and-hold type of investor, you can absolutely ignore the quarterly noise. And you probably can even ignore the annual noise, management guidance or analyst guidance, as long as you feel the company is on track and building and growing over time, and management is making the right moves. The rest can get a little bit too granular, it can be too noisy, can lead you to make poor decisions. Buy and hold good companies that are executing well.

Hill: You went in a slightly different direction. I thought you were going to say you can ignore the quarterly guidance and ignore the annual guidance, as long as you keep listening to Motley Fool Money.

Gross: [laughs] That's what I meant to say!