What is Guidance?
In the stock world, guidance refers to public communication from a company regarding earnings expectations.
How Does Guidance Work?
The world of earnings guidance is large and fluid, whereby the management of publicly traded companies issue public estimates about what they expect earnings to be for the coming quarter. Guidance is based on management's experience, calculations and outlook, and it significantly influences the analysts covering the stock, because the analysts incorporate the information into their own research and earnings forecasts for their clients.
Before August 2000, it was legal for public companies to provide guidance to chosen analysts rather than publicly disclose their guidance. The SEC's adoption of Regulation FD in August 2000 prohibited this selective disclosure of material nonpublic information, and public companies must now publicly disseminate guidance and earnings estimates to analysts all at the same time.
When management becomes aware that the company probably will not meet the expectations it previously communicated, the company typically issues a profit warning via press release or conference call with analysts several weeks before announcing quarterly earnings.
Why Does Guidance Matter?
Guidance considerably influences stock prices because it helps investors evaluate a stock's potential. If investors expect a company to report, say, $0.10 in earnings per share next quarter, but the company actually reports $0.08, many investors might sell the stock and the company's stock price will therefore probably fall after the announcement. Conversely, if the company reports $0.12, the stock price will probably rise. The degree of 'miss' or 'surprise' influences how much the stock price will change. This is why guidance is usually a company's attempt to 'soften the blow' or “fluff the pillows” before announcing earnings.
Some companies do not give guidance. They usually make that choice to reduce legal liability in the event that management's estimates are wrong. Some analysts claim that companies that do not offer any guidance often receive a 'break' on stock price changes when these companies miss earnings, because the market is aware that the company's management has given the analysts (and their resulting estimates) no input.