How to Invest in Equities When Guidance Disappears
The COVID-19 shutdown has prompted an unprecedented number of US companies to suspend earnings guidance. Equity investors should focus fundamental research on a wider range of outcomes instead of the overly precise game of predicting short-term estimates—especially during a period of heightened uncertainty.
Companies are withdrawing guidance on a massive scale as the first-quarter earnings season unfolds. By April 29, 141 US companies with market capitalizations greater than $2 billion had suspended guidance (Display), way beyond anything seen in the worst moments of the global financial crisis. Visibility of business conditions has never been hazier across every sector and industry.
This creates a problem for many market participants. It’s common practice for investors to ground their profit forecasts with company guidance, which tends to anchor their evaluation horizon to shorter-term periods. While investors often talk about focusing on the long term, earnings expectations models typically are calibrated for the next quarter through the current fiscal year.
These models strive for precision with incredible detail. Why? Given the regularity of quarterly earnings, perhaps projections with such short feedback loops provide a sense of control and precision regarding the investment outcome. Regardless of the motivations, companies play into this endeavor by setting guidance they aim to meet and even exceed; how else can you explain that 70% of US companies have beaten quarterly expectations on average since the second quarter of 2013, according to our research. Companies with visibility into their near-term operations feed the predictability of sell-side and buy-side expectations.