Volatility Equities Blog

How to Invest in Equities When Guidance Disappears

01 May 2020

4 min read

John H. Fogarty, CFA| Co-Chief Investment Officer—US Growth Equities

The COVID-19 shutdown has prompted an unprecedented number of US companies to suspend earnings guidance. Equity investors should focus fundamental research on a wider range of outcomes instead of the overly precise game of predicting short-term estimates—especially during a period of heightened uncertainty.

Companies are withdrawing guidance on a massive scale as the first-quarter earnings season unfolds. By April 29, 141 US companies with market capitalizations greater than $2 billion had suspended guidance (Display), way beyond anything seen in the worst moments of the global financial crisis. Visibility of business conditions has never been hazier across every sector and industry.

US Companies Are Suspending Guidance in Unprecedented Numbers

Through April 29, 2020
Based on US Companies that have filed an 8-K form, used to notify shareholders of an unscheduled material event that could be of importance to investors.
Source: AlphaSense, company filings and AllianceBernstein (AB)

This creates a problem for many market participants. It’s common practice for investors to ground their profit forecasts with company guidance, which tends to anchor their evaluation horizon to shorter-term periods. While investors often talk about focusing on the long term, earnings expectations models typically are calibrated for the next quarter through the current fiscal year.

These models strive for precision with incredible detail. Why? Given the regularity of quarterly earnings, perhaps projections with such short feedback loops provide a sense of control and precision regarding the investment outcome. Regardless of the motivations, companies play into this endeavor by setting guidance they aim to meet and even exceed; how else can you explain that 70% of US companies have beaten quarterly expectations on average since the second quarter of 2013, according to our research. Companies with visibility into their near-term operations feed the predictability of sell-side and buy-side expectations.

Short-Term Projections Have Been Shattered

Today, the pretense of precision is gone. While earnings consistency usually breaks down in recessions, the exogenous shock of the coronavirus—and the scale of the fallout—has shattered any attempt to predict the near future. Since the extent of current guidance withdrawals is so broad, we anticipate an even greater dispersion of earnings expectations than we have already witnessed (Display below, left).

Earnings Estimates: Wide Dispersion and Short-Term Horizon

Historical performance and current analysis does not guarantee future results.
Left Display through March 31, 2020; right chart through April 21, 2020
*Based on FactSet annual earnings estimates. Dispersion is calculated by taking the standard deviation of earnings estimates for every stock over the last 100 days, divided by the absolute value of each stock’s median earnings estimate, multiplied by 100. For every period shown, the median dispersion value is used.
Source: FactSet, S&P and AllianceBernstein (AB)

Even if we had more certainty about the near-term outlook, we think relying on short-term measures like next quarter’s earnings per share (EPS) provides false assurance. In fact, measuring a company’s profit potential with only a single point estimate is arbitrary, in our view.

Rethinking Approaches to Earnings Forecasts

This chaotic moment provides a good opportunity to take a step back and reevaluate the efficacy of forecasting EPS and valuing stocks based on price/earnings (P/E) ratios. Even with today’s market conditions, estimation error isn’t the only problem. Because even if we could forecast the S&P 500’s 2020 EPS, any reasonable investor would argue that this year’s profits (Display above, right) aren’t representative of the market’s long-term potential and should be normalized. In other words, the accuracy of estimates doesn’t prove their validity.

Nobody can say whether 2021 will be normal. However, shifting out the forecast horizon by several years reduces near-term variability and noise. It also anchors your perception of the worth of a business to its long-term fundamental success. We believe that it’s more appropriate to ground evaluation scenarios by assessing a company’s profit potential over the next 10 years.

Precisely Imprecise: Modeling Certainty to Cope with Uncertainty

Of course, this approach raises other uncertainties. Long-term investors shouldn’t pretend to be precise. Given the inherent unknowns over such a distant horizon, we think several probable paths of asset growth and profitability should be explored to underpin valuation estimates—in both good and bad times. This exercise not only informs a company’s ultimate profit potential but provides insight into the drivers of today’s profit model that must be rigorously monitored.

That doesn’t mean investors should ignore current operating performance and challenges. However, it means that investors don’t need to accurately forecast near-term results to maintain a fundamental thesis and confidence.

By looking further into the future, investors gain latitude to act differently amid heightened uncertainty. Greater dispersion in EPS is bound to create greater volatility, especially when many companies are suspending guidance or offering projections of questionable validity. These are great conditions for stock pickers. When short-term-minded investors panic and run for the lifeboats, long-term active investors can step in, taking advantage of the weakness as buyers of attractively valued long-term assets with return potential rooted in real businesses rather than spurious expectations.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.

About the Authors

John H. Fogarty, CFA

John H. Fogarty is a Senior Vice President and Co-Chief Investment Officer for US Growth Equities. He rejoined the firm in 2006 as a fundamental research analyst covering consumer-discretionary stocks in the US, having previously spent nearly three years as a hedge fund manager at Dialectic Capital Management and Vardon Partners. Fogarty began his career at AB in 1988, performing quantitative research, and joined the US Large Cap Growth team as a generalist and quantitative analyst in 1995. He became a portfolio manager in 1997. Fogarty holds a BA in history from Columbia University and is a CFA charterholder. Location: New York

This information is for exclusive use of the wholesale person to whom it is provided and is not to be relied upon by any other person. It is not intended for retail or public use and may not be further distributed without prior written consent of ABAL.
This webpage has been prepared by AllianceBernstein Australia Limited (“ABAL”)—ABN 53 095 022 718, AFSL 230 698. Information in this webpage is only intended for persons that qualify as “wholesale clients,” as defined by the Financial Markets Conduct Act 2013’, and is not to be construed as advice. This webpage is provided solely for informational purposes and is not an offer to buy or sell securities. The information, forecasts and opinions set forth in this webpage have not been prepared for any recipient’s specific investment objectives, financial situation or particular needs. Neither this webpage nor the information contained in it are intended to take the place of professional advice.
You should not take action on specific issues based on the information contained in this webpage without first obtaining professional advice. Past performance does not guarantee future results. Projections, although based on current information, may not be realized. Information, forecasts and opinions can change without notice and ABAL does not guarantee the accuracy of the information at any particular time. Although care has been exercised in compiling the information contained in this webpage, ABAL does not warrant that this webpage is free from errors, inaccuracies or omissions. ABAL disclaims any liability for damage or loss arising from reliance upon any matter contained in this webpage except for statutory liability which cannot be excluded.
No reproduction of the materials on this webpage may be made without the express written permission of ABAL. This information is provided for persons in Australia only and is not being provided for the use of any person who is in any other country.

How to Invest in Equities When Guidance Disappears

Short-Term Projections Have Been Shattered

Rethinking Approaches to Earnings Forecasts

Precisely Imprecise: Modeling Certainty to Cope with Uncertainty

More For You