Research published in Accounting Horizons in June 2017 shows that a company's ability to meet analyst forecasts gets more attention than any other measure of its performance. When companies fail to meet predictions, their stock prices can fall dramatically. To protect yourself from the effects of disappointing results, you may wonder whether you should adjust your revenue to meet investor expectations.
Research shows that companies in five business sectors, technology, consumer, manufacturing, health care and "other," are uncannily good at exactly meeting or slightly exceeding analyst forecasts. Analysts at the University of Calgary discovered this trend by reviewing quarterly financial reports over a period of 16.5 years. Professor Rong Zhao, who led the study, said these findings indicated that managers in these companies understood investor expectations and knew how much weight investors put on revenues compared to company earnings.
Company managers have to balance the desire to grow their business by increasing revenue with the need to increase margins by increasing earnings. The recent study suggests the desire to meet analyst forecasts has a big effect on how companies decide to balance these two goals. Failing to meet an analyst forecast can lead to stock prices plummeting; companies have a big incentive to manage their accounts so their revenue is always just enough to satisfy the predictions.
According to Professor Zhao, young companies are more likely to adjust their revenues to meet analyst forecasts than older companies that have been established for many years. Young companies are keen to show their sales are growing, which they do by adjusting their revenues to be higher at the expense of company earnings.
There are strong arguments for adjusting your revenues to meet the expectations of your investors and the analysts who prepare forecasts for your industry. Meeting expectations may increase investors' trust in your business, which may make them more willing to continue giving you financial support. On the other hand, it is important not to lose sight of company earnings completely. All businesses need to make money to stay afloat, even if profitability isn't their main focus during the early growth phase. While increasing your sales to drive your revenue as high as possible and exceed analyst forecasts is often a good idea, you also need to keep an eye on margins to ensure your company can be sustainable in the long run.
Companies that meet or slightly exceed analyst forecasts usually have better-performing stock prices than the companies that fail to meet the forecasts. Meeting the expectations of your investors should be a priority for your business, even though it is not a good idea to completely forget about other goals, such as cutting your company's operating costs and thinking of the future.
Photo courtesy of Stuart Miles at FreeDigitalPhotos.net
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