Infosys may have started the trend but that has surely caught on with other Indian corporates. Today, when companies declare their corporate results, nobody really looks at the results announced. On the contrary, the focus is more on the guidance given. What is earnings guidance? We need to understand earnings guidance as distinct from earnings announcements. Earnings guidance is a futuristic projection of how the growth in top line and bottom line will be in the coming year. An earnings announcement and earnings guidance are different in the sense that one is a statement of facts while the other is a futuristic view on the stock and the company outlook.
Let us first understand why are earnings announcement important?
Every company is required to report quarterly results as well as annual results at the end of the year. In India the financial year concludes in March and therefore we see a spate of annual results coming in the months of April and May. These earnings announcements are statutory requirements as it is part of the listing agreement with the stock exchanges. The quarterly announcement puts out the sales, operating profit and net profit figures for the last quarter. Normally, numbers are compared on a YOY basis i.e. the results of the quarter are compared with the corresponding quarter in the previous year. This captures the cycles of the business better. Earnings announcements are the starting point for analysts to revise their earnings estimates of the company upward or downward. It is also a key document for lenders to judge the financial health of the company and for equity investors to be reassured of the performance of the company. Let us now move on to earnings guidance.
Earnings guidance; its utility and how to interpret it
Not all companies give earnings guidance. For example, even within the IT space, Infosys and Wipro provide guidance on a regular basis, but TCS just provides an analysis and refrains from providing guidance on earnings. Earnings guidance is important in 5 key ways..
Earnings guidance provides a futuristic perspective on top-line growth. When we talk of top-line growth we are referring to growth in revenues. The guidance helps to understand whether the growth in revenues is coming from growth in volumes or from growth in pricing. When the guidance shows higher revenues coming from pricing it is indicative of pricing power return to the company. We have seen this trend in sectors like cement and FMCG. Growth in volumes is indicative of a widening and deepening of the market. Both these have different implications from an analytical perspective.
There is also a margin guidance that is part of the earnings guidance provided. This guidance provides a futuristic perspective on the profitability of the operations of the company in the coming year. This metrics is important because ultimately it is earnings that determine the valuation of the company and it also gives you a view on how the stock price could pan out in the coming year.
For analysts, the earnings become an additional point of reference while making their earnings projections. Normally, analysts use the quarterly earnings as a base for their future projections. Earnings guidance goes one step further and actually allows analysts to pose more pointed questions to the company management. In fact, the earnings guidance is an important guide for analysts when it comes to fine tuning their projections of the company performance and their view on the stock as an overweight or an underweight.
Earnings guidance also plays an important role from the point of view of institutional investors. Large institutions like FPIs, mutual funds and insurance companies give a lot of importance to the management projection of growth in the coming year. This helps them to take a view on whether they should hold to the position or look to switch to alternatives. That is why you will normally see heavy institutional activities in stocks like Infosys around the earnings announcement date as the guidance becomes an important input for these institutional investors to tweak their perspective on the stock.
That brings us to the last question of how to interpret these numbers and the guidance provided. There are some basic rules to follow. Focus on the track record of the company and its performance versus guidance in the last 6-8 quarters. That will give you a clear idea of whether the company is delivering better than its promise or below its promise. Normally, this gives you an important insight into evaluating the stocks from a futuristic perspective.
Earnings guidance has become an important part of the earnings announcement in matured markets like the US. Investors tend to give a lot more importance to the guidance than to the earnings announcements. After all, the stock prices are about the future and that is what the earnings guidance is all about.