ROWAN CLARKE, Investor Relations

Companies with a June year-end are entering a busy time, as they prepare to report their full year earnings. In parallel, the market is constantly forming a view of what those earnings will be. Consequently, there may be a need for a company to take action if the market’s expectations of earnings deviate materially, from what a company is intending to release. In other words, if a company becomes aware that the results they expect to release will surprise the market.

The ASX Listing Rules provide companies with a framework to manage earnings surprises, despite there being no cast iron definition of what constitutes an earnings surprise. The accepted wisdom is that a deviation from guidance of 10% or more, is likely to have a material effect on the value of a company’s securities and the market should be informed. A deviation between 5-10% would need to be very carefully assessed and a judgement call made on whether it is likely to result in a material change in the value of a company’s securities. A deviation of less than 5% is likely not to cause a material change in value of a company’s securities and so the market need not be informed.

Guidance Note 8

With regard to market sensitive earnings surprises, Guidance Note 8 places the responsibility on the Company to have a good understanding of their own information environment and be in a position to judge if the market will need to be informed.

The market will likely draw on different sources of information to form a view on a company’s earnings. These sources may include guidance provided by the Company, which can be in the form of an outlook statement made in the last results announcement, Annual Report or AGM, or from other disclosures (e.g., a trading update) made during the reporting period. It may also encompass de-facto guidance provided by the Company that tends to be informal and lacking the specificity of numbers.

An expectation of earnings can also come from external sources, that includes sell-side analysts who may not always share the same view as the Company on where their earnings will land when announced. While companies are not required to correct an aberrant forecast from an individual analyst, it should be aware of all forecasts being made by analysts to form a reasonable view on what their consensus of earnings is. If consensus guidance provided by analysts differs materially from what the Company is planning to announce, it may be time to take action to address the discrepancy.

When is disclosure required?

Having ascertained what drives market expectations, companies should constantly revisit the circumstances that would trigger a disclosure obligation. Guidance Note 8 provides that:

“An earnings surprise will need to be disclosed to the market under Listing Rule 3.1, if it is market sensitive – that is, if it is of such a magnitude that a reasonable person would expect information about the earnings surprise to have a material effect on the price or value of the entity’s securities.”

Companies need to know that it is the effect on share valuation, and not the magnitude of an earnings surprise that triggers a requirement to update the market. Many factors influence this, including:

• • The extent of the earnings surprise,
  • If the market has an expectation of stable earnings,
  • If near-term earnings are a material driver of value,
  • If the earnings surprise is a permanent one, or attributed to one-off factors, and
  • If the outlook for the Company in coming periods is positive or negative.

It is important for companies to constantly revisit what drives their share price, so they can form a view on what might constitute a material earnings surprise.

Guidance Note 8 does assist companies by providing the following quantitative thresholds for different types of guidance, as potential triggers for a company to consider when updating the market:

• • When an entity has published earnings guidance, and the expected variation is equal to or greater than 10%, or
  • When an entity has not published earnings guidance, but is covered by sell-side analysts, and the expected variation is equal to or greater than 15% of their consensus.

Notwithstanding this, a fulsome assessment of a company’s information environment to determine what drives share price is always required. It is often the case that an earnings surprise falling below these quantitative thresholds will materially affect share prices and require the market to be informed.

Conclusion

Companies need to be aware that when guidance is provided to investors, whether it be specific or de-facto in nature, they need to continually reassess the assumptions which guidance has been based on. Companies must have a thorough understanding of what drives their share price and take action if a material discrepancy is observed. This obligation is also required of companies when sell-side analysts provide earnings forecasts.

As we enter the final month of the June year-end reporting period, most companies will be getting a clear understanding of where earnings will be, when reported in July/August. Now is the time to review what the market is expecting and respond accordingly if updating is needed.

The Investor Relations team at FIRST Advisers have deep financial markets experience and can assist you in managing market expectations.