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The Guidance Effect, Re-visited

By Maureen Wolff, President and Partner

Three years ago, on the heels of the greatest collapse U.S. financial markets have experienced in decades, in conjunction with IntelliBusiness/eventVestor, we published a study, “The Guidance Effect: Improving Valuation” (PDF 875 KB), that evaluated the impact of increased transparency on equity valuation during the turbulent first quarter of 2009.

The findings supported the thesis that issuing quantitative financial guidance contributes to improved stock performance. Given the climate of fear and uncertainty that permeated Wall Street during the study period, we hypothesized that providing guidance – and thereby increasing transparency for investors – likely had an unusually pronounced affect on stock price behavior at the time.

Given the changes in the macro-environment since then, we decided to re-visit the subject and potentially uncover new insights by examining 2011 data. Although market volatility remained high in 2011, investors were generally less fearful and uncertain than they were in early 2009. As we suspected, in 2011 greater transparency once again was associated with abnormal market returns, but the effects were more subdued than in the prior study.

The White Paper containing a full report on our recent study results is available for download here. The study found that:

  • Companies that provided quantitative financial guidance with earnings announcements, whether beating or missing EPS consensus estimates, realized superior stock returns compared with companies that did not offer such forward-looking insight.
  • The market placed a greater emphasis on performance above or below analyst consensus estimates than on performance versus company guidance. This is a new trend observed in 2011 that stands in contrast to our previous finding that guidance beats enjoy greater upside. This finding may underscore an important transition of investor psyche since 2009.
  • Smaller-cap companies experienced greater volatility than larger-cap names. In both cases, however, providing updates to guidance within the context of reporting quarterly results helped lock in price appreciation or mitigate downside depending on whether news was good or bad.

For investor relations professionals who are tasked with developing and implementing disclosure strategy, including guidance practices, as well as analyzing stock price performance and trading trends, our research suggests that:

  • Corporate financial performance compared with analyst expectations is of critical importance in driving subsequent stock movements, but providing earnings guidance is likely to enhance stock returns regardless of positive or negative earnings announcements.
  • Corporate guidance may have a more meaningful impact for investors in a particular company when market sentiment is unusually fearful and uncertain as it was in 2009.

Regardless of market environment, companies that provide guidance are more likely to preserve valuation in the face of downside news and enhance valuation as a result of upside news, compared with companies that do not. Although there are no silver bullets for solving dilemmas related to communications strategy, the results of this study should serve as a useful guide for investor relations practitioners as they prepare their financial disclosures.

Maureen Wolff is president and partner at Sharon Merrill. Maureen leads the implementation of the firm’s strategic vision and provides high-level strategic counsel to clients. She is a past chairman and board member of the National Investor Relations Institute (NIRI) and a current member of NIRI’s Senior IR Roundtable. She also is a past president and honorary director of NIRI’s Boston Chapter.

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