Trading Guidance Changes
What is guidance?
Guidance is information that a company provides to the public about expected future financial results. Companies are not required to provide estimates of future earnings, but it is a common market practice. In addition, companies often release guidance updates if those estimates change throughout the course of a reporting period. The company may provide guidance about a variety of financial factors including sales projections, capital expenditures, or operating expenses. Guidance, however, usually relates to information about expected earnings per share.
Why does guidance about future earnings matter to the stock price?
Stock valuations are based off expected future earnings. Analysts base their recommendations off current expectations of future earnings. As those expectations change, so does the market’s valuation of the company’s stock. Analysts use current information to make forecasts about future earnings, but those forecasts are subject to change as new information becomes available. Therefore, the information a company provides about its own earnings expectations is extremely valuable.
For example, the market’s current expectation is that a particular company will have earnings per share of $1.50 this quarter. So far this quarter, however, the company’s sales have been higher than it expected. As a result, the company’s expected earnings per share will be closer to $1.60 per share. If the company is earning more, it’s stock should be more valuable to its shareholders because they are earning a greater return on their investment.
Why does the stock price increase when a company gives earnings guidance?
The current market value of a stock represents the market’s consensus about the present value of the company’s future earnings. That price reflects all current, public information about the company. So, when a company gives earnings guidance, that is completely new information to the market, and the stock price must adjust accordingly.
Companies that do provide earnings guidance typically do so as part of a quarterly analyst call or other release of quarterly financial statements. The guidance the company provides sets the market expectation for earnings in the next quarter or year. Each individual company develops a pattern for when it releases this information to the public, and the market expects updates at these times. When the company releases updates to this earnings guidance, however, it is new, unexpected information to the market. If the company issues a guidance update that lets the market know earnings look better than the previous estimate, the stock price will increase in response to this new information.
For example, Red Hat, Inc. released increased earnings guidance on October 2, 2017. Its stock price rose 1.5% throughout the day and about 7.5% over the next week.
Do companies ever issue negative earnings guidance?
Earnings guidance is not always good news, and the stock price does not always respond in a positive way to a company’s earnings guidance. For example, a company may issue an update to earnings guidance because it is not performing as well as anticipated. Falling below market expectations results in a lower stock price. Alternatively, a company could release good news about earnings growth but still have a decline in the stock price if the earnings growth is lower than the market expectation.
Guidance Update Alerts
Since these earnings guidance updates are unexpected market events, it’s important to get news about them as quickly as possible. Sonal alerts its subscribers when a company issues earnings guidance updates so that they can maximize their profit from the trade. If you don’t want to miss out on trading opportunities such as guidance changes, subscribe to get an alert from Sonal Signals when there is a new event in the market.
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