Flying Blind? What Withdrawing Guidance Means (and Doesn’t Mean)

When it comes to company earnings guidance, no news used to be bad news. Back in the B.C. (before coronavirus) days, a company suspending or withdrawing guidance often got punished by the market as investors anticipated bad news or assumed the company’s management was unable to accurately figure out the fundamental picture.

Today, thanks to COVID-19, that may be changing. Many companies withdrawing guidance have actually been rewarded by way of a higher stock price. Unfortunately, a lack of guidance might not seem like a reward if you’re an investor trying to navigate these unprecedented times.

How can you trade when you’re flying blind because companies are unable or unwilling to forecast? Although it does make things more difficult, there are strategies you can consider.

A lack of earnings guidance is arguably a good thing in some ways. It can make investors do a little more of their own homework to assess a company instead of relying on the company itself to set the tone. Maybe consider this a time to firm up some of the old investing muscle that’s softened from being spoon-fed for so long.

With guidance suspended, company assessment goes back to some of the basics, including cash flow and risk analysis. Luckily, this information isn’t hard to find.

Guidance Lacking? No Trip to the Woodshed … Yet

Through mid-May 2020, 114 S&P 500 members had suspended earnings guidance, according to data compiled by Bank of America and reported by Bloomberg. In the five days after doing so, they’ve outperformed the S&P 500 Index (SPX) by 46 basis points, according to the bank’s data.

That’s “despite the fact that guiders have historically traded at a premium to non-guiders,” Bank of America strategists noted.

The current trend of rewarding guidance shirkers could make sense when you consider the context.

“When a company says, ‘We don’t know, we’re leaving it to you to try and decide,’ people often tend to be a little more optimistic,” said JJ Kinahan, chief market strategist at TD Ameritrade. “Those who are putting hard numbers to it, they have an opportunity as an investor to say, ‘There’s no way I believe in those numbers.’ And so you can say they can’t possibly beat those and either sell the stock or not buy the stock with as much enthusiasm.”

No one really knows what kind of impact this crisis will ultimately have on companies, which is why when times are uncertain, it may be responsible to withdraw guidance.

Of course, once a company says it’s not sure how it will do, imaginations run wild on Wall Street. Bank of America data reported by Bloomberg shows that guidance suspenders have seen analysts cut next year’s earnings estimates by 10%, compared with a 7% drop for the S&P in general.

Due Diligence and Fundamental Analysis: Making Your Own Guidance

Assuming the company you’re eyeing as a possible investment no longer stands by previous guidance, you’ll need to rely on other information. If you already own shares of a company that withdraws guidance, you’ll need to determine if it’s time to sell or time to add more shares to your portfolio.

Even if you haven’t been a so-called “fine print” investor in the past, now it’s time to get out the old slide rule and green eyeshades and do a little old-fashioned detective work. Anyone who buys shares of individual companies should be doing this stuff anyway, but it becomes even more essential with companies going mute on their own future earnings.

Once you’ve rolled up those sleeves, where do you turn? You can start with a company’s latest Securities and Exchange Commission (SEC) filings and earnings reports (SEC.gov). There you’ll find information that could offer insight into an individual company’s future, even if it’s not giving you big headline earnings and revenue forecasts.

Investors can use these reports to identify risk factors and cash flow, which can be key to determining a company’s health.

Assessing the Risk Factors

Risks are typically explained in a publicly traded company’s 10q or 10k filings to the SEC. Check the management discussion and analysis section of these filings to find company-specific risk factors and individual developments. You’ll get a better feel for what the company is exposed to in the economy. For instance, if the company said it took a hit because of factor X, you can look and see whether it’s a one-time thing or a secular trend in which the market is changing and the company might not be able to rebound.

Of course, COVID-19 is the key factor in the current economy, so any SEC filings are likely to detail a company’s potential exposure on that front. Don’t let that be the only thing you check, though. The world might feel like it stopped because of the virus, but many of the same challenges a company faced previously are still out there, and in some ways could be more threatening.

Consider a company like Boeing (BA), which already faced an existential crisis due to the fatal crashes and grounding of its 737 MAX. That hasn’t gone away, but the problem is exacerbated by COVID-19 because many of BA’s customers may be unable to buy new planes even if the 737 MAX should get its wings back.

For more insight on potential risk, consider listening to earnings calls. Analysts on these calls often ask company leaders about risk factors, giving investors a chance to hear thoughts straight from executives about risk and how the company intends to address it.

Cash Flow

Throughout this crisis, you’ve probably heard many analysts and TV talking heads suggesting that investors focus on companies with strong cash flow because they’re positioned to get through with less damage. So where do you find information on cash flow? Once again, it’s time to check corporate filings.

Take a look at the company’s cash flow statement, which is most often found in quarterly or annual earnings reports. An easy place to start is a company’s investor relations page, which often has links to SEC filings or downloadable financial statements.

How much cash is a company generating? The price-to-cash-flow ratio is a popular measure many investors use to compare one firm to another.

If a company is generating a lot of cash, it may have more flexibility and opportunities, including expanding or acquiring other companies. Free cash flow can be an important way to value an asset.

During this time of COVID-19 and guidance suspension, consider checking earnings reports and earnings call transcripts or recordings for any potential red flags. 

If a positive cash-flow trend begins to decelerate or decline, it can be a warning signal for investors. Be wary of a company that’s reporting increased earnings but decreased cash flow during the same period.

And if a company isn’t producing enough cash flow to cover capital expenditures, debt payments, or dividends, it could mean the company has to borrow to meet these payments. A steady downward trend in cash from operations in normal times could point to weak management. It might also indicate poor use of assets and resources.

Bottom Line on Guidance (or Lack Thereof)

In the COVID-19 era we’re in now, a declining cash flow could point to problems beyond a company’s control. But a look at past trends might help you decide whether it’s a temporary blip or a look at things to come.

Withdrawing earnings guidance doesn’t necessarily mean bad news, but rather uncertainty. Conducting your own due diligence can help you fill the void. But really, doing your homework should always be part of the investment process. Company executives aren’t omnipotent, and their guidance doesn’t always tell the full story.