NEW YORK — Google Inc. has provoked quite a fuss by refusing to provide profit forecasts to analysts and investors. Despite complaints that this breeds uncertainty in the market, Google is actually one of many companies that have spurned a practice that may have few benefits and multiple drawbacks.
The most obvious advantage to ditching this often quarterly ritual is to avoid the temptation for minor earnings manipulation and the other potentially perverse baggage that comes with forcing such an overly near-term focus on management. But there's also the possibility that many of the perceived benefits of communicating an earnings or revenue target for each quarter are exaggerated.
The practice was fairly uncommon before two major regulatory shifts over the past decade. First came the Private Securities Litigation Reform Act of 1995, which provided legal protections for "forward-looking statements" — a tired phrase now uttered robotically with any public comment from a company. Then came Regulation Fair Disclosure, or Reg FD, which forbade any guidance disseminated to a select group of analysts or investors, prompting some companies to clam up and others to adopt a more formal forecasting regime.
Among roughly 4,000 companies with revenues greater than $500 million, the number issuing any profit guidance rose sharply from just 92 in 2004 to about 1,200 in 2001 before leveling off the past few years, according to a new study by the consulting firm McKinsey & Co. based on data from Thomson Financial.
In terms of regular quarterly projections, the numbers have also risen sharply, from 52 of the Standard & Poor's 500 in 1999 to a peak of 243 in 2002, before trailing lower to 229 last year, according to Zacks Equity Research.
Both readings show that a majority of companies large and small don't see the need to micromanage investor expectations, making Google's decision less remarkable.
Nonetheless, the Internet dynamo's no-guidance policy has generated considerable consternation among Wall Street analysts, who've come to expect more hand-holding from companies as they try to forecast profits in an industry where business trends are notoriously volatile.
Google's stunning growth since it went public in August 2004 has repeatedly outstripped expectations by an unusually wide margin. Where most companies report quarterly profits within a few pennies of the average analyst forecast, Google topped the consensus by at least 14 cents a share in each of the company's first five quarters. As a result, analysts have been forced to revise their estimates again and again, shining a less-than flattering light on their forecasting abilities.
Against this unpredictable backdrop, Google's shares more than quintupled by early 2006. Google's quarterly profit report finally came up shy of these guidance-less analyst guesses in late January — by a whopping 22 cents a share — sending its stock into a sharp tailspin that's only recently abated.
Despite the wild ride, Google has steadfastly refused to issue quarterly targets in public, a switch co-founders Larry Page and Sergey Brin maintain would sacrifice long-term goals in the name of short-term growth.
The disdain and impatience emanating from analysts is understandable, given the embarrassment factor. But that's hardly sufficient justification for Google or any company to start playing the forecasting game. While recent displays of calculating pragmatism have tainted the image of purity Google has tried to maintain, Page and Brin aren't necessarily wrong for sticking to their guns, both financially and idealistically.
Beyond reducing stock volatility, the list of presumed benefits often attributed to quarterly guidance include a more generous valuation, possibly as reward for the added certainty in future profits.
McKinsey's researchers reject this premise: "Our analysis of the perceived benefits of issuing frequent earnings guidance found no evidence that it affects valuation multiples, improves shareholder returns, or reduces share price volatility," the report by Peggy Hsieh, Timothy Koller and S.R. Rajan says.
Even the expected reduction in stock volatility may be a myth, undermining arguments that Google could have avoided its rollercoaster ride with quarterly guidance. The study determined that for companies that start guiding analysts, price volatility was as likely to increase as decrease compared with those that don't provide forecasts.
The only significant impact McKinsey detected was a short-term increase in trading volumes when companies began providing quarterly forecasts, a benefit for short-term traders, but few other interested parties.
Meanwhile, the burdens and risks of issuing forecasts are not trivial. "Providing quarterly guidance has real costs, chief among them the time senior management must spend preparing the reports and an excessive focus on short-term results."
The dangers of that obsession are well known. At one extreme was Fannie Mae's misguided efforts to "smooth" its performance. At the other were full-blown accounting deceptions at Enron and WorldCom. And in the middle, there were all those hundreds of companies that mysteriously managed to beat expectations by a penny or two every quarter with stunning regularity during the bull market frenzy.