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Guidance Predicts Share Prices
With December quarter earnings reports starting to
pour in, you need to know about major changes in the way that the pros
interpret them.
Until recently, most players focused on reported
earnings vs. analysts’ forecasts. A firm’s stock went up if it beat
forecasts, and down if it missed. But that was then. Now, savvy
investors pay more attention to what the reporting firm’s management has
to say about the future, than what happened in the last quarter. Here’s
why.
Something New
It used to be that earnings reports contained mostly management’s
comments about the recent quarter, some financial highlights such as
revenue and earnings figures, along with selected financial statement
information. The reports still include those elements, but within the
last couple of years, something new, “management guidance,” has popped
up on many reports. Management guidance is the company’s sales and/or
earnings forecasts, typically for the current quarter and current fiscal
year.
When management provides guidance, analysts and
other market players tend to make their buy/sell decisions by comparing
management’s estimates to existing analyst forecasts, rather than on the
last quarter’s action. As you’ve probably guessed, if management
guidance exceeds existing forecasts, the stock goes up. If the new
guidance is below forecasts, the stock drops.
Trend Persists
What isn’t so obvious is that, although the stock reacts to the
news immediately, the effect often persists for weeks into the future.
That is, a stock that moved up on the news when management announced
guidance ahead of analysts’ forecasts will often continue moving up for
some time. Same thing is reverse. Stocks that dropped when management
guided below forecasts often fall further over the next couple of
months.
While both revenue and earnings guidance are
significant, I’ve found that comparing management’s revenue guidance to
existing analyst forecasts works better than earnings for predicting
future stock direction.
Revenue Forecasts Scarce
Of course, to do that analysis, you have to have access to
analysts’ revenue forecasts. To my knowledge, only two sites available
to individual investors, Reuters Investor (www.investor.reuters.com)
and Yahoo (finance.yahoo.com),
provide analysts’ revenue forecasts.
I’ll describe how you could do the revenue forecast
analysis using Reuters’ forecasts for Zimmer Holdings. The orthopedic
device maker is scheduled to report its December quarter results on
January 29.
From
Reuters’ homepage, select
Stocks and then enter Zimmer’s ticker symbol (ZMH) in the Stock
Information box to get a
price quote. Then select
Financial Highlights and scroll to the bottom of the report to see
analyst consensus (average) revenue and earning forecasts for the
current quarter, the next quarter, and for the current and next fiscal
years.
When I looked, Reuters’ report showed that
analysts, on average, were expecting Zimmer to report revenues of $931
million in its current March 2007 quarter, and $3.8 billion for its
current fiscal year, which ends with its December 2007 quarter.
Best Case
Now, suppose that when Zimmer reports its December quarter
results on the 29th, it says it expects March quarter revenues of $1
billion, and 2007 fiscal year revenues to total, say, $4.2 billion, both
roughly 10% above consensus forecasts. If that happened, the market
would be delighted and Zimmer’s share price would probably move up on
the news, and even better, continue to gain ground for the next few
weeks.
Weak Guidance Sinks Stock
But, what if the news isn’t so good. Say that Zimmer says it only
expects fiscal year revenues of $3.7 billion. Even though that figure is
only slightly below analyst consensus forecasts, many market players
would interpret that news as a sign of slowing growth, and its shares
would probably drop on the news and continue down for some time.
Same problem if Zimmer says it expects $3.8 billion
in revenues for the year (same as analyst forecasts), but only expects
revenues of $900 million in its March quarter, roughly 3% below the $931
million analysts were looking for. Market players would assume that the
March quarter shortfall signaled a long-term slowdown, and management
was being overly optimistic about the year. Chances are, that news would
also send Zimmer’s shares on a downward spiral.
Guidance Trumps Historical
To put it all in a nutshell: a firm s’ guidance outweighs its
historical results. If management projects revenues well above existing
analyst forecasts, its share price will likely move up on the news, and
then continue on that path for several weeks. But shareholders are in
for a rough ride if management guidance falls short.
Conference Calls
Also, you should know that, rather than revealing their forecasts
in the earnings press release, some firms wait for the analyst
conference call that usually follows the earnings release. You can
listen in on those calls, usually on the web, but sometimes only via a
toll-free phone number. The earnings press release usually gives the
details about how to hear the call.
Nothing works all the time in the stock market, and
comparing management guidance to analyst forecasts to predict future
stock price direction is no exception. Consider it another tool to add
to your analysis toolbox.
published 1/21/07 |
