Is the Growing Differential Between Guidance and Consensus Estimates Setting Us up for a Market Correction in Q3?

July 8, 2021

Have you noticed it takes longer than it used to at the drive-thru for your morning java? It’s not because everyone is suddenly drinking more coffee. In a lot of cases, it’s because baristas are in short supply, just like every other type of worker these days.

We all know that companies of every type continue to struggle with the fallout from COVID-19. Labor shortages are one part of the problem. And, widespread supply chain issues and logistics challenges are also playing a significant role. This persistent uncertainty not only impacts near-term results but also longer-term forecasts.

For their part, companies are adjusting their guidance accordingly, though many are being less explicit than they could or should be as to the specific challenges they are facing. The Street, however, doesn’t appear to be listening – or at least not reading between the lines.

The gap between Street estimates and guidance is wider than ever.

Usually, we find that guidance from companies exceeds analysts’ consensus estimates around 50% of the time, give or take. In other words, about half of companies say they will perform better than the Street expects.

Given the unusual times we’ve been operating within, those numbers have, understandably, fluctuated some. In 2019, pre-pandemic, 40% of companies gave full-year EPS earning guidance that was above consensus. And in 2021, mid-pandemic, that number jumped to 57%.

However, as of early June 2021, the number has plunged dramatically: Across all industries, only 20% of corporate expectations exceed analyst estimates. For those sectors where we traditionally expect consensus to be greater than guidance – industrials, consumer durables, like automobiles and recreation products, and electronics – the discrepancy is even more pronounced, with fewer than one out of 10 companies forecasting better outcomes than the Street is projecting. Furthermore, across the board the gap by which guidance differs from consensus isn’t just marginal; it has grown exponentially as well, nearly doubling since 2019.

To summarize, it’s not just that the Street has a somewhat rosier outlook than most corporate executives; the analysts are significantly more optimistic than their counterparts than they ever have been in the past.

The question, clearly, is why?

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*Based on calendar year guidance and estimates for Russell 3000 companies as of 6/10/2021, 6/10/2020, and 6/10/2019
**Data Provided by Factset as of 6/10/2021

Three reasons why the Street’s view doesn’t match guidance.

It’s possible that analysts suspect widespread sandbagging, either intentional or because executives really just don’t know what the future holds, and they want to error on the side of caution. From our perspective, it’s more likely that the Street’s forecasts are skewed by less-than-perfect information. It’s also possible that analysts, without much to go on or the real inside scoop, are simply throwing up their hands.

Here’s what we see as the major contributors to the growing gap:

  1. Generalization of the issues impacting performance.
    • True, companies have adjusted and lowered their guidance in many cases. But, they are not being overly forthcoming when it comes to the reasons why. The vast majority of executives are making blanket statements related to ongoing uncertainty around COVID-19 instead of disclosing details around labor shortages, supply chain issues, production limitations, and/or logistics challenges.
    • With supply chain problems in particular, our own extensive qualitative research shows that very few companies are actually mentioning this obstacle. Despite the fact that critical component shortages are being broadcast worldwide and everyone knows that companies continue to struggle with securing what they need, just as many businesses are saying that they don’t have any supply chain issues as those that are admitting to the problem. As a result, the Street may be seriously underestimating the impact of supply shortages simply because companies are under-communicating them.
  2. Less-than-reliable data.
    • Analysts use past performance to forecast future results. However, the volatility of the past 18 months has led to a lot of outliers in the data – the recent outsized demands for consumer recreation products is just one example. The unprecedented spikes and plunges in demand across various sectors make the data suspect at best while rendering the traditional models used for forecasting less reliable.
  3. Over-optimism related to the future.
    • As vaccinations reach a majority of those eligible in developed countries, and people slowly begin to make their way back to work, talk of high single-digit growth globally seems to be on the rise. Analysts (for once) may be thinking too long term and failing to adjust for short term disruption in their models.

It’s up to companies to reset expectations.

Whatever the reason or reasons for the growing gap between guidance and consensus, it’s obvious that one side is way off target. And that could be setting the stage for a major market correction, or at least for a tough earnings season ahead.

Companies have an obligation to help alleviate the disconnect. Executives can help bring more transparency and stability to the situation by:

  • Pre-releasing, particularly for companies that are late reporters. If you can’t guide accurately, you should be ready to pre-release your numbers. There is no room for surprises in this market. And you can expect your stock to get punished if others report missed revenues on account of supply chain conditions, and you don’t. Also, go out with as fulsome of a pre-release as you can. Provide a range for earnings and/or cash flow as these numbers may be closer to expected than revenue.
  • Beefing up disclosure. Avoid the blanket COVID-19 statements. Instead, include detailed communications on the specific challenges your company is facing right now, including supply chain issues, labor shortages, and production and logistic challenges. And, clearly outline your expectations for market demand. Yes, it’s hard to know exactly what’s in store given the roller coaster ride we’ve all been on for 18 months. But you can speak to what you’re hearing from your customers and other industry leaders. And you can lay out your income and expense assumptions as best as you can.
  • Re-affirming your future plans. Being forthcoming about your challenges can obviously have a downside impact. Help mitigate any negative effect by speaking to your solutions and reassuring investors as much as possible about the soundness of your future strategy. Again, transparency is the key here. Being as detailed as possible about your expectations for what’s next can help inspire investor confidence in your business’ long-term success.

It remains a critical time to get your financial narrative right. It’s fair to say that many businesses have faced more turmoil in the past 18 months than they have in the last 18 years. And the ride isn’t over yet. As was the case during the heart of the pandemic, the post-pandemic period demands straightforward, transparent, and ongoing communications with investors and the Street. The more detailed you can be, the more likely consensus will be more accurate, or at least closer to accurate. And that’s good news for your investors and your bottom line.

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