In the aftermath of the 2008 financial crisis, the practice of quarterly earnings guidance was put under the microscope for consuming inordinate time, frequently missing the mark, and heedlessly shifting focus to short-term tactics at the expense of long-term value. Years later, the practice persists. Now there are renewed calls to abandon it.
On Aug. 17, President Donald Trump tweeted a call for eliminating quarterly earnings updates, joining a debate that has been simmering for years. Trump said he has asked the SEC to study the issue.
Here’s the key concern: Providing guidance to investors on the upcoming quarter’s earnings per share (EPS) may cause management to myopically focus on short-term results, rather than encouraging companies to build for the long run.
The subject reached a crescendo of sorts when Larry Fink, CEO of BlackRock, the world’s largest investment firm, wrote a letter in 2016 to the CEOs of the S&P 500 urging them to end the practice of quarterly reporting guidance.
“Over time, as companies do a better job laying out their long-term growth frameworks, the need diminishes for quarterly EPS guidance,” Fink wrote. “Today’s culture of quarterly earnings hysteria is totally contrary to the long-term approach we need.”
Since the letter’s publication, more companies have been weighing the idea of doing away with their earnings forecasts.
“There’s definitely a movement away from quarterly EPS guidance,” said Tim Koller, partner and member of McKinsey & Company’s strategy and corporate finance practice.
Better performance proxies
Other consultants affirm that EPS is not a useful performance indicator. “The market is fixated on EPS guidance, when what investors really need is context,” said Neri Bukspan, CPA, CGMA, a partner in EY’s financial accounting advisory service.
He explained that investors are looking for a trajectory of what the company did last quarter and last year, and how business will be better next quarter and next year. “For example, how will it make money because it expanded into a new territory, and will that major litigation against the company be resolved soon?” he said. “The underlying information is more important than the actual EPS amount.”
Chris Ruggeri, national managing partner of Deloitte Strategic Risk Business, shared this perspective. “What’s important is what the financials mean,” said Ruggeri. “Sure, investors are thirsty for financial data, but what they’re really looking for is a road map indicating the path from now to the future.”
Koller said, “What’s more important is what a company expects its revenue growth will be for the year, whether or not its margins will be up, down, or stable, and what its likely tax situation will be under the new tax laws. This is more useful to investors [than EPS guidance] because it tells them how the business plans to achieve its expectations.”
The ability of companies today to make much better predictions of their quarterly expectations puts a wrinkle in the discussion of earnings guidance. Using automated financial and accounting software solutions, companies can post journal entries, match transactions, and reconcile accounts in near-real time. These solutions often incorporate robotic processing automation (RPA) to reconcile accounts and transactions continually, as opposed to undertaking these tasks en masse at quarter end.
“It’s often easier for large companies to close their books because they have typically invested in automation and close tools, resulting in less hassle when it comes time to report to investors,” said Graham Smith, former CFO at Salesforce and an independent member of several boards today.
But others, like Mario Spanicciati, chief marketing officer of BlackLine, a Los Angeles-based provider of financial and accounting automated software, said the true value of the technologies is their use by management for business purposes and not necessarily for earnings guidance.
“It could be good to get rid of all the quarterly minutiae at the street level, but accounting still needs to happen internally,” Spanicciati explained. “Companies still need metrics to operate the business and rigor around the financial controls.”
Adds Koller, “The most important responsibility for business leaders and boards is to manage the organization to create long-term revenue and competitive health. A backward look is always good, but what’s more important is looking forward.”
Russ Banham is a Los Angeles-based freelance writer. To comment on this article or to suggest an idea for another article, contact Drew Adamek, senior editor, at Andrew.Adamek@aicpa-cima.com.