March 14, 2006

Should Google Give Out Earnings Guidance

Wall Street Analysts have been pestering Google to fall in line and start issuing Earnings Guidance to the stock market. Even though Google insisted at the very beginning, 18 months ago that they would not indulge analysts with any such results, since they are looking for long term investors, and such an activity would ensure short term investing. But now when Google's profits have fallen below industry expectations, the pressure is mounting.

Earnings guidance is defined as, the comments management gives about what it expects its company will do in the future. These comments are also known as "forward-looking statements" because they focus on sales or earnings expectations in light of industry and macroeconomic trends. These comments are given so that investors can use them to evaluate the company's earnings potential.

This brings us to the all important question, that are the guidance earnings necessary at all? There were two articles today, one in CNN and the other in Forbes pointing out the two sides of the coin.

This is why Calit Murphy, from CNN Money, is against issuing guidance
The experts suggest that 71% of the companies issue yearly guidance. Even though this is the norm, it is not a good practice since
1. It embeds perverse incentives (to manage the numbers rather than the business); relies on dubious assumptions; and feeds into a short-term mentality.
2. Not giving guidance does not mean not giving information. Earnings are part of the equation but not the only variable.
3. Good economic performance is a process, not a number. Even the Chinese Communist Party gets this concept. Their five year plan does not feature an economic growth target becaus they found that if it set a number, they got it - by hook or, more commonly, by crook.
4. Companies do the same. Burying expenses under the rubric of "restructuring"; timing asset sales; piling up debt; or squirreling money away in reserve funds are among the means desperate managers have used to hit their targets. None have anything to do with running a good business.
5. Good management requires that numbers be servants, not masters. And Guidance figures are at best Educated Guesses.
6. Examples from the present include, CEO John Thain, of the NYSE(Research) which went public recently, who indicated that analysts could expect no earnings guidance from them. In the past, Warren Buffett, from Berkshire Hathaway (Research), never gave them either. In contrast, Carly Fiorina made mistaken earning guesses in 2000 that lost $23 billion of Hewlett-Packard's (Research) market value in three days, bringing what guidance are supposed to avoid, volatility.

On the other hand, Vahan Janjigian, from Forbes says
1. The long run is really nothing more than a consecutive string of short runs. Indeed, short-run achievements are the best indicator we have of whether the firm is on track to achieve its long-run goals.
2. Well-run firms have to make short-run plans anyways, since it is part of the budgeting process. Management will still know what it expects for short-run sales and profits. It simply won't tell the investing public. Which would bring about greater uncertainity.
3. He argues, that if all the analysis hasn't resulted in more accurate earnings projections, why in the world does anyone think that the elimination of guidance will make things better?
4. The bigger fear, of course, is that bad management teams will hide behind the "no guidance" shield.firms may find it all too convenient to simply keep bad news hidden just a little bit longer in the hope that it will simply go away over the next quarter or two.

I am not a stock market analyst, but I can relate to the reason why Warren Buffet or the guys at Google, decide not to provide Earnings Guidance. The reasons for it being very simple. I am a software engineer and like all the rest of them I work for a manager, and I have an account manager who handles the client. Now the account manager would like to know exactly how much time I would take to complete the job, even before I start off. Now this case is in many ways similar to the situation between a company and the analysts. I am the company, my manager is the company's internal analysts, who would know if we are meeing expectations or not. The account manager is the analyst, who needs to answer to the final client.

Now what are the options that I have in front of me, when asked with the question, about how much time I would need for the job. If I go with the first option, of specifying exactly how much time I would need, based on experience, I would add the time required to identify the bug, the time required to rectify it, and finally the time to test it properly and then some time to complete the formalities. This is my internal analysis (which would be a lot more complicated in the case of a company). Based on all calculations, I would say that I would be making the delivery by Tuesday.

Most of the times, I would be on time. But consider the case, when I take more time than I had initially allocated for the first stage. But since I have already commited, I would have two options, one would be to go and tell my manager that I'm running late and I would need more time. But it wouldn't do much good to my or my manager's track record to shift the ETA further, so we shut up and try to get it done within the time that's available. What happens in this case is that the part which gets compromised is testing. Which I now know, through really bad experience, that it would lead to a lower quality of work. Some mistakes would creep in over time, and without a complete check up if the delivery reaches the client, it wouldn't be exactly what we promised to deliver.

Now consider, the second case that I discuss with my manager on the expected ETA, but tell the account manager, that we cannot say with utmost certainity how much time would actually be needed. We describe to him, that the whole process would consist of three parts (which I have described above) and we would be able to commit on the exact date till we know for sure.

I have observed, other the last couple of years, that the second method of handling work, makes sure that the clients receive a better quality of work since I am emphasizing on each of the stages of the process rather than fighting the clock to be on time. A task will take up as much time as it requires. And if I take up some extra time on a job, it does not necessarily mean that I am inefficient or unable to perform my job properly. And the client, though might be pissed for a day or two, would value our quality work much more than coming back to us to fix another bug which crept in last time.

In all cases, it is the markets who will decide eventually. Yet personally, I think it should be left up to the individual companies to decide for themselves, as earning guidance is not as necessary to a Good business as the analysts say.

(Against: CNN)
(For: Forbes)

(Also see: link, link, link)

(Crosspost: Desicritics)
(Tagged: Desipundit)

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