Why Would a CEO Stick with Quarterly Guidance?

I read an interesting take on this question today and I think it has a lot of merit. While many of us would prefer public companies abandon quarterly guidance, there are reasons why a CEO would keep giving it out. One reason might be to make them look good, and therefore enhance their job security.

If you are an active investment manager (whether for personal assets or professionally) you have likely observed in recent years that a pattern has developed during earnings season on Wall Street. Companies tend to beat estimates for the most recent quarter and guide estimates lower for the current and/or future periods. The end result is that most quarters finish with earnings coming in ahead of estimates on the whole.

While stock prices might dip in the short term because investors care more about future guidance than earnings already booked, this practice sets the bar very low. By keeping expectations meager, it maximizes the odds that the company will beat numbers next quarter, and that makes management look good. Under-promise and over-deliver (“UPOD” as Jim Cramer calls it). It works, and it’s what public companies should do in general (although maybe less often than every three months).

I think this is a great explanation for why many companies will keep playing the guidance game. It sets the bar low, makes them look like they’re doing a good job running their companies, and boosts their job security. If you don’t give guidance at all, the analysts could set the bar too high, forcing you to miss numbers and get an earful from investors.

How can investors play this growing trend? Buy stocks after a post-earnings sell off due to a guide down. After the company sets the bar low, investors adjust their valuations accordingly. Over the next couple months, Wall Street will realize the numbers are too low and the stocks will get a boost as strong performance is priced in again. Use that strength to pare off positions before the next earnings report if you think they might be lackluster or conservative.

That seems like the best way to trade the ever-growing trend of beating earnings and guiding lower for future quarters.