I recently came across a university paper* that looked at developments in European company research produced by the banks since the introduction of new regulation at the beginning of 2018 (MiFID ll). As an ex-analyst, I was somewhat surprised about one conclusion, namely that the quality of research had improved. Now this has nothing to do with the fact that the industry is having to do without my contribution but was based more on my experience that, what comes across my desk these days, tends to be mainly what you might call “maintenance product”, usually covering company results, which often regurgitate what was already in the corporate press release, with
On closer investigation, it became clear that “quality” here was being defined as how accurate the future earnings estimates produced by analysts were proving, rather than an assessment of their bright thoughts about a company or industry and its prospects. I suspect that this may be more a comment on the fact that companies had become more precise about how they were presenting financial guidance for the future, which the analysts then put into their models, rather than how smart the analysts actually were.
And now the world has changed. During the COVID-19 crisis, the vast majority of companies have withdrawn guidance, on the back of a very uncertain world. Even in the ultra-safe area of consumer staples, there are only a few gold standard names like Nestle which have stayed with their outlook statements, whereas most have taken the lower risk option.
I can see quite an incentive for companies to stay with this approach, even when the COVID-19 mist starts to clear. It has become quite a game for companies to manage the analyst consensus of estimates, to ensure that it accurately reflects where the company believes that its results will come out, as they are under pressure from Stock Exchange regulation (in this case the Market Abuse Regulation), to issue a trading statement if there is a material gap opening up. If you drop guidance, the likelihood is that the range of analysts’ forecasts will become much more varied. This leaves the company with a wide consensus range and removes the need to keep updating financial markets if trading either gets a bit better or worse than expected.
In addition, it is not yet clear whether the post-COVID-19 world is going to be any more predictable than where we are today.
And there is certainly a school of thought out there that asks whether these analysts and investors ought to be earning their keep by using their grey cells to complete their own models, rather than being spoon-fed by the company through detailed guidance.
So am I suggesting an easier life for company finance departments and the Investor Relations function in the future?
Not at all. If a company is not giving absolute guidance to financial markets, I think it needs to provide analysts and investors with a lot more building blocks in order for them to do sensible modelling.
It was not coincidental that, back in March, the UK regulatory body, the Financial Reporting Council, realised this quite early and put out advice that companies should endeavour to produce sensitivity analysis for the impact on the business from several scenarios resulting from COVID-19.
A few companies, such as Tesco, Asos and Britvic, took this to heart and have set out some detailed scenario modelling, and from what I hear, analysts and investors were very appreciative. Surprisingly, these have tended to be the exception rather than the rule so far, and I think that companies should not forget that analysts and investors will remember those companies that tried to help them, whilst also not forgetting those that did not.
And, however you look at it, a move towards less company guidance also promises to make life tougher for those working in financial markets, as well as other stakeholders, such as the media, that often rely on analyst input to determine whether the corporate news is better or worse than expected.