Two friends met over lunch and and the talk veered to the recent performance of stocks in their portfolio, and the reasons thereof.

Om: Hi Anil! Noticed how HCL Tech fell around 7 per cent last Friday, with the BSE IT index too getting pounded? I heard that it is due to some earnings pre-announcement made by the company. I am worried about it as I am holding some IT stocks in my portfolio. Can you please explain earnings pre-announcement?

Anil: Sure. Earnings pre-announcements are basically voluntary disclosure made by a company regarding its earnings guidance, which is issued before the scheduled quarterly earnings announcement. Here they pre-announce any positive or negative changes to the earnings expectations previously made. However, generally it is for negative changes. For instance, as you pointed out, HCL Technologies, in its pre-announcement, reduced FY23 revenue growth guidance to 13.5 per cent from 14 per cent previously estimated, citing deterioration of macro-economic conditions leading to vendor consolidation.

Om: Okay, understood. But why are such pre-announcements made?

Anil: Through such announcements prior to earnings, the management attempts to remove information asymmetry by communicating important financial or operational information to stakeholders in the interest of transparency and to avoid rude shocks later on. Pre-announcements help investors get an understanding of future earnings guidance and analysts in making adjustments on account of change in certain fundamentals. This shows the company’s transparency in the investment community and indicates how much clarity and understanding management has in the business, which translates into earnings guidance ahead of time.

Om: Got it. So, this means that companies releasing pre-announcements might have different impact on their stock price compared to those coming out directly with quarterly results. Right?

Anil: Exactly. Earnings pre-announcements lead to change in analyst estimates for the forecast fiscal year earnings and hence there’s an impact on stock price prior to earnings. Ultimately, on account of such pre-announcement, the stock might be protected from wider swings on the day of actual results announcement as investors might already have some idea of potential earnings surprise. For instance, US retail major Walmart issued a press release in July this year indicating lower earnings outlook for Q2 and FY23 on account of inflation concerns. After the pre-announcement, the stock fell around 7.5 per cent in a single day. After a few weeks, when the actual earnings announcement happened, the stock didn’t react sharply. On the whole, the overall impact on stock price of company making pre-announcement won’t be as high as the one that doesn’t.

The stock of the company reporting earnings completely different from the consensus estimates might not just get impacted on account of earnings miss but also lead to questioning of management’s integrity and capability with regard to alerting the stakeholders about any changes. US-based Boston Beers’ Q2 FY21 earnings missed analysts’ estimates by around 30 per cent following which the stock tumbled more than 23 per cent in a single day. Factors such as shifting consumer preferences led to underperformance in some of the company’s segments which should have been communicated to investors via pre-announcements.

Om: Okay, so ultimately to have fewer surprises during the actual earnings announcement, there should be timely pre-announcements by a company’s management if earnings are going to be significantly different from the estimates on account of some specific event.

Anil: Correct, there you go!