When it comes to companies forecasting how much money they're going to make or releasing news regarding their income, the last thing Wall Street wants is a surprise.
Phil Tomlinson, chairman and CEO of credit-card processor TSYS, found that out in October 2005. In an earnings release, he almost casually mentioned that a major customer, Bank of America, was exploring the possibility of taking its business elsewhere — something it would eventually do — and that the outcome of negotiations could not be predicted.
The following day, TSYS shares were scorched on the New York Stock Exchange, tumbling out of the gate to post a nearly $2-per-share loss, a nearly 9 percent decline. The fall came despite the Columbus-based firm reporting a 23 percent profit during the quarter.
But Stock investors and analysts are constantly trying to predict the future. Thinking months, perhaps even years, ahead is a common phenomenon that can gyrate company stock prices higher and lower. And if traders get even a sniff that earnings guidance might be off down the road, punishment can follow.
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"You can get penalized so bad if you miss your guidance number," said Jim Lipham, chief financial officer at TSYS, which does business globally, including in the U.S., Europe, Asia and South America.
"You really don't want to surprise the market with your operations," Lipham said. "You like to have some kind of guidance out there so they know where you're going or what you're trying to do. I think at TSYS we've always spent a lot of time analyzing the upcoming year."
More or less information?
That said, there have been calls from all sides — corporate America, industry groups, former securities regulators and even some shareholders — to end the practice of companies releasing earnings-per-share forecasts each quarter.
Giving investors less information on which to base their earnings expectations could introduce more volatility into financial markets, some say, and could let companies bury potentially bad news for longer. The issue first surfaced earlier this decade after business scandals at Enron, WorldCom and others were in part blamed on executives cooking their company’s books to meet their quarterly earnings-per-share estimates. According to critics of guidance, those cases highlight why investors place too much emphasis on whether companies beat, match or miss their profit estimates, down to the last penny per share. They say it can lead corporate managers to perform creative accounting to get ahead, maybe by moving up sales or delaying charges. Over the last five years, major companies like Coca-Cola Co., AT&T Corp., Google Inc. and McDonald's Corp. all announced they were stopping quarterly or annual earnings-per-share guidance. About 66 percent, or two-thirds, of companies give guidance, according to a 2006 survey by the National Investor Relations Institute of 654 of its members. That’s down from 77 percent in 2003. Among those who think guidance as we know it should come to an end is the Committee for Economic Development, a Washington think- tank whose members include former Securities and Exchange Commission chairman William Donaldson and former New York Federal Reserve Bank head William McDonough.
‘‘Quarterly guidance is at best a waste of resources and, more likely, a self-fulfilling exercise that attracts short-term traders,’’ the committee said in a report issued in late June. It called on corporate board directors to change the short-term earnings culture and lashed out at hedge funds for trading on the gap between forecast and reported results. ‘‘Companies that drop quarterly guidance have one fewer reason to manage earnings.’’ The U.S. Chamber of Commerce and the Aspen Institute, — a group comprised of CEOs, labor unions and other business groups, — also have advocated ditching quarterly earnings revisions and sticking with a single annual forecast.
Cloninger: Change may confuse investors
Still, it's highly unlikely that every company will reduce the flow of information that ultimately settles into an earnings forecast. Kriss Cloninger, president and chief financial officer of supplemental insurer Aflac Inc., seriously doubts his Columbus-based firm will cut back on guidance. The company, famous as much for its duck ad campaign as for its health and accident policies, already has reduced guidance from 2 years to 1 years. One of the reasons the executive is confident with Aflac's earnings guidance is that its business is relatively stable, and the company has a history of nailing its earnings marks. Under chairman and CEO Dan Amos, Aflac has met or exceeded its operating earnings-per-share guidance 15 consecutive years. The forecast numbers are based on the foreign currency exchange rate in Japan not changing from when the guidance is issued. About 75 percent of Aflac profits come from the Asian nation. "Most years our guidance has been in the 15 percent range," Cloninger said. "We've had a 15 to 17 range and we've had a 13 to 15 range. We're usually on the high end of the range or slightly in excess of the range." The financial executive understands why some companies may be leery of going out on a limb and predicting how much income they will have over a specific quarter, much less a year or more down the line. Revamped securities laws and a litigious society have given shareholders much more power to sue should a firm miss its guidance, he said. But dropping guidance or changing it dramatically might send a confusing signal to analysts, shareholders and potential investors, he said. "The shareholder's going to think there's some fundamental change in the business or some increase in uncertainty that is just not there," Cloninger said. "And it would actually damage the current shareholders because the analyst community would say, ‘Oh, there's reduced visibility on Aflac earnings. We can no longer assume that they're going to increase at whatever specified rate Aflac provides for a period of time.’” Not that steady-as-she-goes Aflac hasn't taken its lumps occasionally on the stock market because of news or financial disclosures. Cloninger recalls a release on slumping sales knocking the firm's stock down $6 a share. A week later, however, it had recovered $5 of the loss after investors digested the news and pushed the price back up to a fair value. The needle can easily swing the other way as well. In January, TSYS apparently surprised market analysts, beating earnings expectations by 18 cents per share. The next day its stock jumped, shooting up nearly $4 a share before settling at for a one-day gain of just under $3 per share. "I don't really predict the market," said TSYS' Lipham. "We just try to give the earnings that we think we're going to have. And we don't really worry about it." Neither does the management at Aflac. "It's our job to manage through that," Cloninger said. "We wouldn't be frustrated in changes in stock prices, per se, because changes in stock prices occur when news hits the street, either positive or negative news. "We also know that the market tends to overreact one way or the other to news. But over a period of time, and it's usually a short period of time, there's a correction" that pushes the stock back to a reasonable level.
Crunch time: It's all in the numbers
But how do companies come up with earnings guidance?
TSYS collects financial data from its 600 call centers and other divisions and affiliates, Lipham said. Each has their own forecast, which is consolidated at the corporate level — using lots of computers, of course — and followed by an executive-level meeting in which the final earnings-per-share target is set.
Aflac's guidance is comprised of certain criteria. They include: new policy premium sales, investment yield rates on money it takes in, claims the firm expects to pay out, operating expenses it faces, and "persistency" of the insurer's business. "We crank all of that together, and we do it separately for the U.S. and Japan," Cloninger said. "We then consolidate it all at the corporate level and factor in various capital management things we do — share repurchase, changes in shareholder dividends — and we come out with an estimated bottom line EPS." For the record, Aflac's earnings per share guidance for 2007 is growth of 15 to 16 percent. Over the past year, TSYS went from gauging a 15 to 17 percent decrease in earnings in 2007 — much of it due to losing Bank of America business — to growth of 20 to 22 percent because of expense controls and increased revenue. TSYS' parent company, meanwhile, Columbus-based Synovus Financial Corp., a regional bankholding firm, has projected its earnings will rise between 9 percent and 10 percent this year. All three of the publicly traded companies will release their financial reports next week for the second quarter period that ended June 30. TSYS is first on Monday, followed by Aflac and Synovus next Tuesday. Shareholders and analysts alike are waiting to see how the companies' earning guidance pans out.
The Associated Press contributed to this report.