Faulty forecasts have been the downfall of many CFOs. Last year, two telecom giants, Motorola and Ericsson, saw their CFOs depart amid massive cuts in revenue projections (Motorola) and unpleasant surprises regarding profits and share price (Ericsson).
Despite the heavy toll exacted when investors don’t get what they expect, companies continue to struggle with accurate forecasts — both internally and in what they report to Wall Street. New research from The Hackett Group finds that two-thirds of the 70 companies it surveyed (U.S. and European) missed their forecasted earnings by at least 6 percent, up to a high of 30 percent. According to Hackett, the number of companies that consider themselves to be at “high risk” of missing forecasts has jumped to 14 percent, from a mere 2 percent three years ago.
Companies should switch to rolling forecasts, Hackett argues, which can better capture changes in the markets. They should also avoid punishing people for delivering bad news. “You need a process that tries to bring an objective view,” says Hackett’s Brian Hall, explaining that it is important to have a culture where bad news can be communicated early.
Despite problems with forecasts, few companies seem ready to abandon them. Last summer the National Investor Relations Institute found that 58 percent of 752 companies surveyed provide annual estimates, while 27 percent issue quarterly estimates. Firms taking a longer view said it gave them the chance to be more nuanced, and that it did not negatively affect valuation or stock prices. Some companies have taken that argument to its logical extreme, of course, by eliminating earnings guidance altogether. However, an August 2007 academic study argues that this is not the answer, as companies that scrapped guidance saw no increase in R&D or capital investments. Moreover, 31 percent of the 222 companies reviewed resumed quarterly guidance after 18 months.