Why Earnings Guidance Is So Important To Investors

Investors always look toward the future. It is one of the most fundamental aspects of the stock market that you have to learn. A company can report earnings from the last quarter that are spectacular but if their guidance for the future is subpar, its stock will go down almost every time. Here is a good example from this week:

Under Armour (UA) reported great earnings: Profit rose 28 percent and revenue rose by 22%. Both numbers were above analyst’s estimates. In all segments of the company, Under Armour reported revenue increases. So what did the stock do for the day?
UA

The next day (Wednesday) the stock continued to fall, ending down another $1.08 or 3.28%. So why did the stock go down so much when the reported results seemed to be so good? In short, it was all due to poor future guidance which is again, one of the most important aspects of any earnings call. 

UA

***It must be noted that companies are NOT required by any rules or regulations to report guidance and many of them choose not to. Google is one that never gives guidance. But many others do report it, believing that it helps them gain the trust of investors and shows that they are up front and honest with the investing community. 

Poor Guidance Can Kill A Stock

Every quarter, there is a couple week period where a majority of the big name companies release their earnings. Its report card time, and investors can reward or punish them in big ways. But just as important as the profit-loss, revenue, and other numbers that each company might give, are the forward projections about what to expect in the next quarter. All the numbers they report for the just completed quarter, no matter how good (or bad) they are, can be overshadowed by poor (or good) guidance going forward. 

It is important to learn this if you want to really understand how the stock market works and how investors view stocks.

To help you understand this another way, here is a picture of the Millennial Tower in San Francisco. It is an super high end condominium skyscraper with all units costing in the millions. It would be an enviable place for anyone to live and only the very rich can afford it. But there have been just a few units for sale in the last couple of months and the ones that are for sale are lowering their prices. You see, the tower has become headline news after it was revealed that the building has sunk 16 inches because it was built on a landfill and it surly has more sinking to go. You can see the slight tilt in the picture.

Millennium tower

Just like a stock, there is lots to love about buying a unit in this building but what about the future? What will happen with the lawsuits and the uncertainty over how this can be remedied and whether it can ever be fixed at all? Would you spend millions of dollars for a unit in a building that has this kind of future problems even though the units themselves are fit for a king right now?

Thats what guidance is in the stock market. Things may be great for a company right now or last quarter but if the guidance going forward is bad, the stock becomes much less desirable.

And thats what happened with Under Armour this week as management said that 2017 and 2018 would see a slow down in growth as the company focuses less on maximizing short term profits in order to focus the health of the company long term. 

Guidance Can Be Good Too

While good earnings with poor guidance seems more memorable to investors because the pain of a falling stock price always hurts, things can go the other way as well. Sometimes companies will come out with earnings that seem only so-so or even on the bad side, but surprisingly the stock goes up the next day. Upon further research you will find it is because the CEO or someone on the earnings call said some things that point to a turn around or better times ahead. If things are looking up, investors will be interested in buying the stock even if the just reported financial numbers that aren’t that good. 

Guidance is perhaps the most confusing thing to novice investors because it is hard to understand how much the future really matters. I know when I first started investing, it was difficult for me to understand why, in investor’s minds, the future matters so much more than the present. I thought that if a company reported a great quarter, the stock should go up every time. But it doesn’t work that way as the reported earnings are old news and may not accurately reflect the future prospects for a company. 

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