Dorion-Gray: Changes in forward guidance, analyst outlooks affect stocks

Do you know what you will be doing and what the world will be like in 2015? Caterpillar, the big yellow construction equipment manufacturer, apparently does.

There’s an old Wall Street ritual where executives from publicly traded companies meet with investment analysts to discuss “forward guidance” on their company’s earnings and business outlook. The analysts slice and dice the executives’ comments and use them to help formulate earnings projections and “price targets” for the stock. These projections and price targets get disseminated to stockbrokers and other “buy side” investors who use this data to help make their buy and sell decisions.

This “dance” between company executives and Wall Street analysts can be a bit tricky because there are all kinds of rules regarding what the company can and cannot say. And, of course, companies don’t want to divulge too much information because it might help their competitors. Despite the potential drawbacks, some companies issue a wide range of earnings and revenue growth forecasts while others simply say they’re “comfortable” with what the analysts are currently projecting for their company’s earnings. Still others avoid the scene completely and make no projections.

If there’s a material change to the “guidance” from one of the analyst meetings, the company’s stock often goes on a wild ride, either up or down.

Given all the issues surrounding the issuance of earnings guidance, it was quite interesting to learn that Caterpillar recently met with analysts in 2012 and cut its earnings forecast for 2015. That’s right, 2015! Now, how many of you know what you’ll be doing or what the economy will be like in 2015?

On one hand, we should praise Caterpillar for its bold transparency. Few companies go out on a limb like that and give analysts a three-year earnings projection. Unfortunately, Caterpillar’s stock wasn’t exactly rewarded for its openness.

The company lowered its earnings forecast for 2015 and said, “We've seen a slowing in economic growth more than we expected.” The next trading day after its announcement (Sept. 25, 2012), Caterpillar’s stock dropped 4.2 percent, according to data from Yahoo! Finance.

In addition to a company changing its guidance, investment analysts may change their “earnings projection” at any time during the year, regardless of whether there’s been any announcement from the company. Netflix is a good example.

During a one week period in early October 2012, analysts from two different investment banks made positive comments about Netflix, according to Motley Fool. The result? The stock jumped about 30 percent during the period.

But, what the market giveth, it can taketh away.

On Oct. 9, 2012, another investment bank came out with an opinion on Netflix. This time, it was a negative call and the stock dropped about 10 percent that day, according to MarketWatch.

As these two examples show, individual stock prices can be volatile.

This is not a buy or sell recommendation for Caterpillar or Netflix. We’re simply pointing out how company earnings guidance and analyst investment changes can dramatically affect stock prices. The swift reaction in Caterpillar and Netflix stock suggests this information flows quite quickly.

To be a successful investor in individual stocks, you need to have the resources to analyze how changes in forward guidance or investment analyst outlooks may affect a stock. Sometimes, these changes represent buying opportunities; other times, they may call for hitting the sell button. Knowing the difference between the two can make a big difference in your wealth.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial adviser prior to investing. All performance referenced is historical and is no guarantee of future results.

• Please send any financial questions you wish to have answered in this column to Dorion-Gray Retirement Planning Inc., 2602 Route 176, Crystal Lake, 60014. You may also fax them to 815-455-4989 or email Paula Dorion-Gray, CFP, is a Registered Representative of Securities America Inc., member FINRA/SIPC.

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