Why "Guidance" is Anything But

Most publicly traded firms comment in advance of their earnings releases to give the market "guidance" on what it thinks its earnings will be in the coming quarter and/or year. But is the "guidance" really that? What motivation does a company have in this environment to give guidance when things are looking up? There are three possibilities when a company comes out and says "we think we are going to make x dollars a share in the coming quarter". First, the company hits the number exactly, in which case the market says "hey, the company did what it said it would do" and the stock continues to trade in the range it was in. Second, the company misses low, in which case the market panics and sells and the stock drops like a stone (and after enough of these reports, shareholder lawsuits ensue). Third, the company misses high, in which case the market moves up on the "surprise". It is clear that the third option is what every CEO is hoping for. I ask you, how do you maximize the chances of exceeding your guidance? If your answer was "Guess Low", then you win the prize.

You can't trust guidance. In fact, companies should stop giving it. It only creates an imbalance in the market. Let professionals analyze the public information and let the market digest their musings. The analysts, for all of their faults, are much more likely to be giving impartial opinions about what a company's prospects are. They have no "skin in the game" other than to be accurate. The company and its "guidance", however, is motivated from an entirely different place. Just my opinion.

Happy Trading!