Transparency vs. Turbulence
Navigating Earnings Guidance in Emerging Markets
Earnings guidance, publicly traded companies’ practice of providing financial forecasts and expectations to their investors and stakeholders, is a common practice for companies throughout the world. It offers transparency, sets expectations, and helps build trust among shareholders and the broader financial community.
The following explores the nuances of earnings guidance, highlighting disparities between emerging and developed markets, as well as a discussion of how companies should approach this when competing against international peers.
The Importance of Earnings Guidance
Earnings guidance serves as a compass for investors and analysts, enabling them to make informed decisions. It typically includes revenue and profitability projections along with other financial and operating metrics. The main benefits are:
1. Build Credibility: Providing guidance demonstrates a commitment to transparency, which is fundamental to attracting and retaining investors’ trust. This also helps management reinforce its conviction in the company’s future performance, demonstrating they can deliver, thus building and enhancing credibility.
2. Expand Visibility: Guidance is particularly relevant for small-to-mid-market cap companies seeking to attract their ideal investor base. Smaller companies tend to be negatively impacted by low trading liquidity, and even to lower profitability if in the early growth phase. These companies often do not screen well, making them more difficult to find. These challenges, often compounded by a lack of information available to model future performance, make it more challenging to garner sell-side coverage and investor interest.
3. Limit Volatility: Providing guidance helps manage expectations of shareholders, analysts, and the market at large- reducing the likelihood of sudden negative surprises or overly optimistic expectations. By controlling the message, companies that provide guidance take control of shaping investor perceptions about future potential. Without guidance, the market is forced to rely more on external- and often unverified- sources to set estimates while management is still held accountable for meeting a “sell-side consensus” without being empowered to control or inform this consensus. Note that the need for guidance to mitigate volatility is less relevant for widely-followed, must-own mega-cap companies.
4. Reduce Cost of Capital: Accurate and consistent guidance can result in a reduced cost of capital, as investors will be more confident in the company’s ability to meet expectations.
5. Support Valuation: Guidance helps investors in valuing a company and its fair share price.
The truth is that most companies understand this. Even those which don’t provide specific revenue or earnings guidance typically provide directional commentary that the markets can process reasonably.
Four Pillars for Effective Guidance
Earnings guidance isn’t just a numbers game; it’s a strategic communication tool that enables companies to guide investor expectations, reinforce trust, and outline a vision for the future. As markets continue to evolve and investor demands grow more complex, mastering the nuances of effective guidance becomes increasingly vital.
Whether you’re steering a company through the turbulent waters of an emerging market or charting a course in a more developed capital market, the following four principles remain relevant.
1. Transparency: The market expects companies to issue guidance that’s relatively conservative but credible. A key consideration is to ensure you’re being transparent in terms of what is included in the guidance and the drivers behind these expectations. Including one-time events within projections which have not been properly disclosed to the market often results in surprises that hurt credibility.
2. Assumptions and Scenario Analysis: Meeting or exceeding guidance by a small amount is paramount to building and maintaining credibility. Given the volatility in emerging markets, it’s essential that annual guidance includes assumptions of the key external variables that could impact performance. Therefore, when the context changes, guidance can be more easily adjusted to reflect the current environment, as the rationale was previously laid out, mitigating surprises and protecting management’s credibility.
3. Long-Term Focus: Shift the investor focus from short-term results to long-term value creation. Share your company’s strategic vision including a mid-term outlook.
4. Stakeholder Engagement: Engage with stakeholders regularly to build trust and gather valuable feedback and insights.
Companies disclose regular estimates of financial metrics to effectively manage the financial community’s expectations. This, for example, includes revenues, costs, capex, units sold, cash flow, and other key financial and operational KPIs. However, not all data holds the same significance to the financial community.
In developed capital markets, particularly the U.S., companies will also provide quarterly guidance, including EPS expectations, in addition to setting full-year expectations.
However, many companies stopped providing guidance during the Pandemic, and some discontinued guidance altogether. Many of those that resumed guidance are only providing full year guidance on key operating and financial metrics that help convey a broader view of the company’s performance.
Even before the pandemic, many executives were questioning the benefits of quarterly guidance. Jamie Dimon and Warren Buffett’s 2018 Wall Street Journal Op-Ed addressed how the “unhealthy focus” on quarterly earnings and the pressure to meet these estimates leads companies to hold back strategic initiatives such as spending, hiring and R&D.
European companies, in contrast, refrain from providing quarterly guidance- instead prioritizing a longer-term approach through annual guidance often complemented by a mid-term view. This is aligned with the UK´s 2014 discontinuation of quarterly reporting, followed two years later by the EU only requiring mandatory bi-annual reporting.
The Emerging Markets Dilemma
However, emerging markets companies may face a different landscape:
1. Volatility: Emerging markets tend to be more volatile, with currency fluctuations, political instability, and economic turbulence adversely impacting financial performance. This makes it challenging to provide accurate guidance. Providing net income & EPS guidance, a common practice in the U.S., is generally not expected given the significant FX and tax impacts that distort results. Many companies operating in volatile markets will also provide a guidance range to account for increased uncertainty. As can be expected, providing clear assumptions behind companies’ key business drivers becomes particularly relevant. Many companies also provide sensitivity analysis. Banks, for example, discuss margin sensitivity to a 100 bp change in interest rates while oil and gas companies tie performance scenarios to a change in oil prices.
2. Competitive Pressure: Emerging Markets companies competing with developed market peers face unique challenges. These peers will often provide more detailed and frequent guidance, putting pressure on emerging market firms to do the same. This is particularly the case in the tech industry, where many peers are U.S.-based.
3. Regulatory Differences: Emerging markets may have less stringent regulations, particularly around disclosure of inside information, or fewer reporting requirements, making it easier for companies to avoid providing guidance regularly.
4. Market Maturity: Certain emerging markets have an investor base that is less aware, also with fewer covering analysts. This can reduce the perceived benefits of providing guidance.
Challenges can also result from resource limitations, due to budget constraints and limited infrastructure necessary to ensure frequent and accurate guidance. The resulting information asymmetry also poses a significant hurdle, as investors and analysts often have limited access to comprehensive data about these markets.
Emerging markets issuers with a focus on elevating their financial community disclosure and communications can best address these multifaceted challenges by prioritizing close financial community contact. This ensures a deep understanding of potential information gaps, disclosure needs and market disconnects. Companies that take ownership and control of their messaging, and of the integrity of the information the financial community can access to evaluate your opportunity, are consistently best positioned to compete with developed market counterparts.
InspIR elevates your company’s IR communications. Contact our experienced team:
Susan Borinelli, Partner, susan@inspirgroup.com
