While negative guidance drives short-term stock price declines, positive guidance drives short-term and long-term gains
S&P Capital IQ and SNL, a business unit of McGraw Hill Financial (NYSE:MHFI) and a leading provider of research, analytics and data, released a new research note today which charts the impact of corporate earnings guidance on a company’s stock price.
The report, What Does Earnings Guidance Tell Us? analyzes the stock market performance of Russell 3000 companies following the issuance of positive and negative corporate earnings guidance between 2003 and 2015 using the S&P Capital IQ Estimates database. It finds that negative guidance by company management, which is common and foreshadows quarterly earnings performance below analysts’ consensus estimates, is correlated with negative short-term stock performance, but has no material impact on longer-term performance. Conversely, positive guidance, in which company management signals they will beat consensus earnings estimates, is associated with significant stock price gains over short- and longer-term time horizons.
Following were the report’s key findings:
- Positive Earnings Guidance Drives Stock Gains: When management issues optimistic guidance (guidance that is higher than consensus estimates), the 3-day excess return surrounding the announcement date was 3.07% over the study period. Over longer time horizons, companies yielded excess return of 1.3% and 2.5% during the one- and three-month periods following a disclosure of optimistic earnings guidance.
- Negative Earnings Guidance Drives Short-Term Declines: When companies issue conservative guidance (guidance that is lower than consensus estimates), the 3-day excess return was -4.17%. Over longer time horizons, the results were not statistically significant over the study period.
- Building a ‘Good News’ Portfolio: A portfolio formed by purchasing companies with positive guidance news over the last month outperformed the market by 0.69% per month after controlling for market, size, value and momentum risk premia.
- Negative Guidance Far More Common than Positive Guidance: The conventional wisdom on earnings guidance is that corporations use it as a means to temper market expectations ahead of earnings season, so they can beat consensus estimates. Indeed nearly 70% of quarterly earnings guidance fell below consensus estimates during the study period.
“Intuitively, all investors read into company earnings guidance as an indicator of management sentiment for the future, but there’s always been uncertainty around the precise correlation between the tone of that guidance and subsequent stock performance,” said Dave Pope, managing director, Quantamental Research, S&P Capital IQ. “Our research proves that investors should listen closely when corporate management announces good news, particularly when it’s announced prior to an earnings release.”
The new research note, What Does Earnings Guidance Tell Us? was produced as part of the S&P Capital IQ Quantamental Research team’s ongoing Event Driven Investing Series.