Earnings guidance. It’s become a staple in the financial world, a regular ritual accompanying every quarterly earnings report. But this seemingly modern practice of companies predicting their future performance is actually an age-old tradition dressed up in new clothes. So, is it truly a crystal ball for investors, or just smoke and mirrors?

Let’s break down what earnings guidance is, why it matters, and why some companies are starting to say “no more” to this Wall Street custom.

Simply put, earnings guidance is a company’s public prediction of its upcoming financial performance. Think of it as management’s best guess of what the next quarter’s, or even the next year’s, earnings will look like. 

Investors and analysts cling to these pronouncements, using them to adjust their expectations and decide whether to buy, sell, or hold a company’s stock. But there’s a catch: these figures are far from foolproof. They can be missed, manipulated, or simply misunderstood.

Before the days of the internet and instant information, earnings guidance existed in a murkier form — the “whisper number.” This was an era when select analysts received privileged insights from companies, giving their clients a potential edge. 

The SEC put a stop to this selective whispering with Regulation Fair Disclosure (Reg FD) in 2000. Now, companies must broadcast their predictions to the entire world simultaneously, ensuring a level playing field for all investors.

At its core, earnings guidance plays a vital role in the investment process. After all, who knows a company better than its own management team? They have the inside scoop on everything from sales trends to upcoming product launches. Guidance, in theory, bridges the information gap between companies and investors, contributing to a more efficient market where stock prices accurately reflect a company’s true value.

However, the cynics among us argue that guidance is just a tool for manipulation. In booming bull markets, companies might inflate their forecasts to attract eager investors looking for high-growth stocks. Conversely, during bear markets, they might lowball expectations, making it easier to “beat the number” come earnings season. Remember the dot-com bubble? Many analysts failed to see through the overly optimistic guidance of internet companies, leading to disastrous consequences.

In recent years, a growing number of companies have decided to ditch earnings guidance altogether. Their reasoning? It promotes an unhealthy obsession with short-term results. Warren Buffett’s Berkshire Hathaway is a prime example. Buffett has long argued that focusing on quarterly earnings distracts from long-term value creation.

But does eliminating guidance actually solve the problem? Critics argue it merely shifts the focus, potentially increasing volatility. Without guidance as an anchor, analysts’ estimates become more dispersed, leading to wider variances from actual results. Imagine a stock swinging wildly because a company missed earnings estimates by a few pennies! This increased volatility could make the market a more turbulent place.

Analysts rely heavily on earnings guidance as a starting point for their own financial models. They dissect management’s assumptions, scrutinize industry trends, and conduct their own independent research to arrive at their own earnings forecasts. Without guidance, their task becomes more challenging, potentially leading to less accurate predictions.

Investors, on the other hand, use guidance to make informed investment decisions. But they must be wary of blindly following management’s predictions. Savvy investors dig deeper, considering factors such as the company’s track record, industry conditions, and overall economic climate.

So, what does the future hold for earnings guidance? Will it remain a cornerstone of financial reporting, or will more companies follow Berkshire Hathaway’s lead and abandon the practice? Perhaps we’ll see a shift towards alternative approaches, such as providing qualitative commentary on business trends without specific numerical targets.

One thing is certain: the debate over earnings guidance highlights the tension between short-term market pressures and long-term value creation. Whether guidance ultimately helps or hinders this balance remains to be seen.