Earnings guidance was once sacrosanct at mighty General Electric.
In the 1990s and 2000s, when the conglomerate was run by CEOs Jack Welch and then Jeffery Immelt, meeting and beating earnings guidance was the name of the game for General Electric (ticker: GE).
The company’s guidance was so good that it became a crutch. Investors rarely worried about General Electric missing its forecasts. And another earnings beat meant the stock was a Buy. It was a “set it and forget it” approach to investing.
That crutch broke during the 2008-2009 financial crisis and the decade that followed. Over the past 11 years, GE has missed analyst’s earnings estimates–which are always informed by company guidance–about 25% of the time. Over that same span, Honeywell (HON), the industrial conglomerate GE tried to merge with decades ago, has missed analyst’s earnings estimates twice.
The problem with guidance hinted at larger problems in the organization. In 2017, the last year Immelt was CEO, GE’s guidance for earnings from its industrial operations was $2 a share. That works out to, roughly, $17 billion or $18 billion in operating profit from all of GE’s businesses, excluding GE Capital.
That guidance turned out to be too aggressive. Since 2017, the best four consecutive quarters for GE’s industrial businesses have produced about $12 billion in operating profit. The average annual operating profit for GE’s industrial business is less than $10 billion, a far cry from $18 billion.
How did GE’s guidance go so wrong?
Answering that question is important for investors, especially as the hundreds of companies that abandoned giving guidance in 2020 due to the pandemic are offering guidance again.
According to data tracked and analyzed by Dow Jones Newswires, nearly half of the companies in the S&P 500 withdrew their guidance last year amid pandemic. In the Dow Jones Industrial Average, a smaller, more manageable data set, Barron’s found some similarities. Of the 21 companies that gave material financial guidance in 2020, 10 withdrew guidance. Today, 17 of those 21 companies are back to offering guidance.
That’s good news for investors, according to 3M CEO Mike Roman. There is reason for caution, but “we got enough of a view for guidance [that] returning to guidance is a good sign,” he tells Barron’s.
3M (MMM) is a diverse conglomerate that serves myriad industry from auto manufacturers to microchip makers to healthcare providers. Industry dynamics make setting guidance easier or harder, depending on the sector.
Wireless telecom provider Verizon (VZ), for instance, seemingly has some guidance-setting advantages. For example, they have a list of subscribers paying monthly fees. That consistent revenue stream meant Verizon continued to offer guidance in 2020. For 2021, Verizon expects to earn about $5.08 a share, up from $4.90 earned in 2020.
There is still some art in setting guidance for Verizon. “I’m making no assumptions about international roaming revenue returning any significant way for example,” CFO Matthew Ellis tells Barron’s. He doesn’t want Verizon’s guidance to run ahead of the global travel recovery.
Many manufacturers can predict further ahead. Global auto makers, for instance, plan production for months ahead, giving auto suppliers decent visibility. Electrical components supplier TE Connectivity (TEL) guided one quarter ahead when reporting its most recent results. CEO Terrence Curtin tells Barron’s both top-down–such as global production estimates from auto industry data IHS–and bottom-up factors–like estimates given by TE’s customers–go into setting their guidance.
Still, TE prefers to stay conservative with its guidance coming out of the pandemic. It’s easier to provide forecasts for shorter periods.
Automation equity supplier Zebra Technologies (ZBRA) recently issued quarterly and full-year 2021 earnings guidance after suspending its full-year guidance during the pandemic. “The quarter and year are different,” Zebra CEO Anders Gustafsson tells Barron’s. “The [full] year is harder.”
Zebra has good visibility into the quarter ahead because sales from customers with ongoing projects with Zebra are easier to predict. Inventory in distribution channels, as opposed to the sales done directly with larger customers, is just one of many confounding factors for Zebra to consider. For Zebra, a lot of business is signed and delivered in a short period leaving the company to estimate sales based on historical patterns.
Sometimes history is a bad predictor. Just listen to what GE’s Immelt tells Barron’s about issuing that historic $2 guidance: “By the time of 2016, I had been [giving guidance for 15 years. I felt like I had a good handle on what the company was capable of in terms of numbers … plus bottom-up [analysis] from the team supported it. I understand the criticism, and [$2 guidance] certainly didn’t last long after I left … It wasn’t done casually. It was done with great seriousness and great effort.”
GE is thought of as a long-cycle business. Many of its products, such as jet engines, are purchased many years ahead of delivery. For Immelt, that meant he missed some key trends that would eventually hurt the GE power business.
GE issued guidance earlier this year after withdrawing 2020 guidance this past April due to the pandemic. In 2021, the company expects to earn about 20 cents a share and generate roughly $3.5 billion in free cash flow. That compares with 1 cent in per-share earnings and $600 million in free cash flow generated this past year.
“We have 30 businesses … we [take] every one through a strategic review,” CEO Larry Culp tells Barron’s about his approach for setting guidance. “The muscle we are trying to build is not just [forecasting] the PnL, but the balance sheet and cash flow statements as well. That is new.”
Building balance sheets and cash flows statements gives GE a greater ability to project items such as free cash flow. Requiring more from GE businesses also gives Culp the ability to incentivize management based on more than bottom-line numbers.
Companies also need to remember to be conservative. Over promising, like GE did in the latter part of the past decade, is one sin investors have a hard time forgiving.
Guidance was conservative in the second half of 2020, coming out of the depths of the pandemic. Almost 80% of companies in the S&P 500 beat analyst estimates, a proxy for beating the company’s guidance. That’s about 10 percentage points better than the previous year.
For investors, the job in 2021 is to figure out if this year’s earnings guidance is conservative enough. Believing bullish forecasts is one investing sin the market will always punish.
Write to Al Root at allen.root@dowjones.com
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