The Hindu Business Line : Should markets dance to guidance?

ON ONE side, we learn that the taxman has slapped a Rs 50-crore notice on Infosys and, on the other, there is the news that the company has raised its guidance under US GAAP for the year ending 2006. More on the positive guidance you'd know from a page of ``real-time SEC filings'' on www.nasdaq.com; Form 6-K dated April 29 filed by Infosys speaks of revision to its `financial outlook' of consolidated earnings per ADS, by 3 cents, because a $8-million charge towards ESOP expenses anticipated for fiscal 2006 is getting pushed by a year. In contrast, only last week, a disappointing guidance from the company had dampened sentiments on Dalal Street.

A press communiqué dated May 2 of Electronic Data Systems Corporation (www.eds.com) reports 2005 Q1 results and highlights that its Q1 ``pro forma EPS'' exceeds guidance, and that its quarterly revenue at $4.94 billion is ``at high end of guidance''. Weeks ago, there were relatively good numbers from Satyam for the fourth quarter; and to match the feel-good, the company's guidance was in line with market expectations, analysts opined. Another IT player, Wipro, gives credit to its ``broad-based growth'' for revenues of $375 million, ahead of its guidance of $370 million.

But what is guidance? "An effort by companies to provide analysts with sufficient information to create revenue and earnings projections," defines http://investor.news.com. However, analyst predictions often precede the company's guidance. For instance, a recent report on www.thestreet.com notes: SRA boosted fourth-quarter earnings guidance by a penny to 52 cents a share and guided toward revenue of $229 million. Those figures are in line with the Thomson First Call analyst consensus estimate."

One may say that company guidance and external estimates feed each other. And markets are known to react to every new input, be it from either source. When the guidance is downward, the scrip dives, as it happened when Amazon's shares fell nearly 4 per cent after the company said last week that its operating income would drop as much as 42 per cent in the second quarter. For the opposite, there is the example of Lockheed Martin; it reported Q1 earnings that were ahead of the average forecast of the Wall Street analysts, though the company's Q1 sales missed the average estimate, as www.newratings.com informs.

Guidance is for the future, a realm that is risky to tread, especially if one is talking of numbers. "No forecast of projections relating to financial performance of the issuer company shall be given in the offer document," mandates SEBI in the Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines, 2000. Even the profit forecast needs an auditor's certificate, as Schedule XIV therein would stipulate.

The Institute of Chartered Accountants of India issued more than two decades ago a Guidance Note on ``Accountants' Report on Profit Forecasts and/or Financial Forecasts,'' more driven by lenders' perspective than that of investors. So, we don't have as yet any Guidance Note on `guidance'. Nor does SEBI have anything on guidance such as what IT companies have been rattling the markets with; on www.sebi.gov.in you can catch up with ``investor guidance'' driven by the motto ``an educated investor is a protected investor''. Don't mix up guidance with ``informal guidance'' that SEBI can give in two forms — ``no-action letters'' and ``interpretive letters''.

Since guidance is about future, a phrase that is relevant is `safe harbor', an SEC provision "to reduce or eliminate liability as long as good faith is demonstrated," as www.investopedia.com explains. An interesting link on the site takes you to ``Earnings Guidance: The Good, the Bad and Good Riddance?'' by Rick Wayman, President of researchstock.com. Guidance is also known as `forward-looking statements' because of the focus on sales or earnings expectations in light of industry and macroeconomic trends, explains Wayman. "In previous incarnations, `earnings guidance' was called the `whisper number.' The only difference is that the whisper numbers were given to select analysts so that they could warn their big clients," he traces. After such whispers became illegal, in came guidance. Guidance is good because more info is better, argues Wayman. But it is bad when companies manipulate expectations ``to sway investors''.

A debate ICFAI Reader published some time back was whether companies should shun earnings guidance. To know further on the topic, read the commentary by Nanette Byrnes on www.businessweek.com suggesting, that with earnings guidance ``Silence Is Golden'', in the context of many companies abandoning the ``ritual hint-dropping''. By refusing to play the quarterly guessing game, companies reduce the focus on short-term performance, reasons Byrnes. Also, "That lessens incentives for accounting shenanigans aimed only at juicing the numbers."

Paul Favaro's opinion titled ``Resetting the Guidance Game: How to Communicate What Really Matters,'' on www.marakon.com emphasises that transition away from earnings guidance should be to develop a plan and commit to it publicly.

"In so doing, executives can ensure that their dialogue with the market becomes more focused on the true drivers of value in their business, freeing them up to spend less time managing their share price and more time managing their share value."

Rules are for the obedience of fools and the guidance of wise men, said Douglas Bader. Likewise, guidance is for the obedience of inept analysts, one may say, especially when due research gives way to anchors and pegs that company's guidance offers. To them, this quote of Immanuel Kant may sound like an admonition: "Immaturity is the incapacity to use one's intelligence without the guidance of another."

ZeroBase@TheHindu.co.in

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