• Why didn’t you raise your guidance this quarter?
• Why is the range of your guidance so wide?
• Why did you lower (or raise) only the top (or bottom) end of your guidance?
• Why did you widen the range of your guidance?
• Why didn’t you narrow the range of your guidance?
• When is the next time you’re likely to review your guidance?

In a few second quarter conference calls, I sensed an unusual level of frustration among some management teams. That feeling did not seem to relate to questions about fundamental factors influencing revenue or earnings. It revolved around questions about the confirmation or revision of management’s “guidance” about near-term financial results.

Listen in on any publicly held company’s quarterly earnings conference call. Some questioners will request clarification around a point the CEO made in his or her opening remarks. Others will ask a pre-planned question based on their early review of the earnings press release containing the quarterly financial figures. Several will try to extract more details about the recent quarter and about the potential impact of those factors on upcoming periods. A few will probe for opinions and information of a strategic nature. Those at the end of the line for questions may ask for more “color” on a previous answer. It doesn’t happen in every call, but listen to enough of them and you’ll also hear someone ask a question such as those noted above about management’s latest financial guidance, i.e. their forecast for near-term revenue and earnings.

If you thought all analysts developed their own estimates for the revenue and earnings paths of the companies they follow, welcome to the post Sarbanes-Oxley world of Wall Street research. Before Sarbanes-Oxley, industry analysts with their ears close to the ground were free to query managements with the questions they thought were most relevant to obtaining a complete picture of the company’s financial position. Some had more experience, better insight, and a wider variety of industry contacts than others. Such analysts frequently were able to frame penetrating questions that elicited unusually frank responses from managements.

Many corporate executives grew to respect the knowledge, perspective, and judgment of some of the analysts who
followed their companies most closely. Indeed, those managements frequently were both willing and able to communicate important elements of their companies’ present and future condition to the broad investing world through the work of particularly knowledgeable analysts. With 20/20 hindsight, it probably was not a good idea to allow corporate executives to communicate important information only to a handful of favored analysts. And it probably was not a good idea for those analysts to be permitted to pass on that information only to their best-paying institutional investor customers.

Unfortunately, too many analysts abused this privileged relationship with the managements of the companies they
followed. Too many of them chose to abandon their role as objective observers of an industry’s participants, and instead became sales agents only for the securities of their firms’ investment banking clients. They publicly communicated those managements’ self-interested views of their world in written reports distributed to retail investors while simultaneously criticizing those views, and the companies’ true financial prospects, in private communications with selected institutional investors. One of the most painful congressional committee hearings I’ve ever watched on C-SPAN spotlighted the self-serving, dishonest, unethical, yet highly compensated practices of several well-known analysts.

Sarbanes-Oxley was passed to address a variety of issues, including corporate governance, internal controls, financial disclosures, auditor independence, and analyst objectivity. One tangible change in the laws regarding corporate executives’ communications with investors required the disclosure of material pieces of information to all investors and at the same time. They were no longer able to comment privately on individual analysts’ earnings models, to help edit analysts’ reports, or to disclose new information in meetings with individuals or small groups of investors. Some companies interpreted the new rules as not permitting them to guide investors towards the likely results of their financial progress in upcoming quarters. Most, however, adopted the new policy of periodically giving their official “guidance” about such matters, and limiting that guidance to only a few selected line-items such as revenue an EPS.

Every time I write about my former analyst colleagues I try to respect the nature of the work they do, which I still think is useful. When evaluating the future financial results of a company, however, too many investors rely more on management’s guidance than on their own independent analysis of the company, the industry, and the trends.

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Michael A. Martorelli is a Director at the investment banking firm Fairmount Partners. For additional commentary on the topics covered in this column contact him at michael.martorelli@fairmountpartners.com  or at Tel: (610) 260-6232; Fax (610) 260-6285.