Harry Domash's Winning Investing


Revenue Guidance Moves Share Prices

Facebook will report its June quarter (April, May and June) results after the bell on July 26. We’re entering earnings season again and Facebook will be only one of hundreds of stocks reporting June quarter numbers over the next few weeks.

In many instances, a firm’s share price moves substantially in response to an earnings report. What drives share prices up or down? Many factors contribute, but one stands out. Here’s what you need to know.

In the old days, say up to three of four years ago; at report time, stock prices moved in response to how reported earnings compared to analyst forecasts. All else equal, stocks went up if earnings beat forecasts and down when they didn’t. That was then.

Guidance Trumps Results
Now, most firms offer “management guidance” at report time. What’s that? Management guidance is the company’s official sales and earnings forecasts, typically for the current quarter, in this case, September, and for the current fiscal year. Those forecasts might be included in the earnings report press release or announced during the analyst conference call that typically follows the release.

Not all firms provide guidance, but when they do, most analysts and investors pay more attention to the guidance than what happened in the last quarter. Here’s how they use it.

Market players compare management’s new revenue and earnings forecasts to previous analyst forecasts for the same periods. If the management guidance exceeds the existing forecasts, everybody is happy and the stock goes up. If the new guidance falls short, the stock drops. That’s it. It’s that simple. What happened in the (just reported) last quarter isn’t as important.

What’s interesting is that even though the stock reacts immediately, the effect can persist for weeks into the future. For instance, if the stock moved up on the news that guidance exceeded forecasts, all else equal, it will probably continuing moving up for some time.  Same thing in reverse. Stocks that dropped when management guided below forecasts often continue to decline for weeks after.

Revenue Guidance Works Best
Although both revenue and earnings guidance are significant, I’ve found that comparing management revenue guidance to existing analyst forecasts works better than earnings for predicting future stock direction.

How do you know if management’s guidance exceeded or fell short of estimates? You can find analyst consensus earnings forecasts on many financial sites. But Yahoo Finance (finance.yahoo.com) is one of the few sites available to individual investors that display revenue forecasts.

Interpreting Facebook
The June report will be Facebook’s first report since going public. Given its maverick approach to things financial, it’s anybody’s guess whether Facebook would issue management guidance. Here’s how you could analyze Facebook’s revenue forecasts if it does issue them. You could also use the same approach for any company.

From the Yahoo Finance homepage, get a Facebook (FB) price quote and then select Analyst Estimates. When I checked, some 30 analysts had forecast Facebook’s September quarter revenues. The forecasts ranged from $1.18 billion to $1.33 billion. The consensus (average of all estimates) for September was $1.24 billion. To round out the picture, the consensus was $1.15 billion for the June quarter and $4.89 billion for the year.

Suppose that on the 26th, Facebook does issue guidance and says that it expects September quarter revenues of $1.36 billion and 2012 fiscal year revenues to total $5.38 billion, both roughly 10% above consensus forecasts. Facebook’s share price would likely move up on the news, and even better, continue to gain ground for the next few weeks.

On the other hand, say that Facebook only forecasts fiscal year revenues of $4.75 billion. Even though that figure is only slightly below analyst consensus forecasts, many market players would interpret that as bad news and Facebook shares would probably drop and continue down for some time. 

Same problem if Facebook says it expects $4.89 billion in revenues for the year (same as analysts), but only expects revenues of $1.20 billion in its September quarter, roughly 3% below the $1.24 billion analysts were looking for. In all cases, the actual June quarter numbers that Facebook reports would not affect its share price as much as the future forecasts.

Nothing works all the time in the stock market, and comparing management revenue guidance to analyst forecasts to predict future stock price direction is no exception. Consider it another tool to add to your analysis toolbox.

published 7/15/12

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