At a recent financial intelligence session for a Fortune 100 company’s managers, participants asked why the company used terms like strong growth, focused results and maintaining attractive ratios for goals rather than listing actual numbers. And, when it gave numbers, the firm, like virtually every public company, provided a range, rather than specific targets.
The ambiguity boiled down to managing expectations. Investors and Wall Street analysts want firms to be as specific as possible on performance. You’ll hear analysts asking for specific numbers, often over and over, during earnings calls. Company leaders, however, facing the challenges of projecting the future in an uncertain world, prefer to create some much needed wiggle room. The compromise between those positions becomes a range. Once expectations are set, however — whether via a specific number or a range — the company’s stock price tends to gravitate to those expectations. When firms exceed expectations, that can drive value up; miss them and the value may move in the opposite direction.
Interestingly, expectations of performance, rather than the actual performance itself, often define whether the markets see what happened as positive or negative. What I mean is, due to expectations, positive performance can become a negative for stock value and vice versa. While that may sound strange, let’s examine exhibit B to illustrate how expectations can cloud our perceptions. Exhibit B, of course, is my favorite American football squad, the Cleveland Browns. Those who follow the NFL know the Browns have been, well, less than stellar since they team returned to the league in 1999. During the last fifteen seasons, the Browns have posted two winning ones and competed in the playoffs just once. Last year, they lost twelve games, somehow managing to “exceed” 2012’s awful 5-11 finish.
So, how does the Browns’ dismal performance relate to public company stock expectations?
Clearly, expectations for the Browns upcoming campaign are quite low on the Cleveland Football Exchange. If the team somehow posts a .500 record in 2014, fans will be delighted; if it inexplicably reaches the playoffs, they’ll be ecstatic. In fact, if it only wins six games, they can say its results were 50% better than in 2013. The Browns, of course, will still be a bad team, but, because expectations are so low, many fans will be excited that the team is making progress. Contrast that sentiment (i.e., even a losing season will be a winning one in Cleveland) with San Francisco who lost a close contest in 2012’s Super Bowl. Given that success, expectations were extremely high for the team’s 2013 season. When they lost the NFC Championship game to Seattle, the eventual Super Bowl Champions, many labeled 2013 a failed campaign for the 49ers. Despite being only one win away from reaching the Super Bowl for the second straight season, people immediately began evaluating whether the team needed to make major changes. In a bizarre move, it was even rumored the Browns attempted to trade for the 49ers head coach, Jim Harbaugh.
As in football, expectations can and do create stock market reality. Managing them is a key component to building trust with the investment community. Delivering the expected results strengths that trust. Most firms use ranges and somewhat vague terminology about performance to manage expectations. So don’t be surprised when your firm gives a range or when football pundits say the Browns will win somewhere between 3-11 games next season.
Let’s just hope, for long-suffering Cleveland fans, the team finishes closer to eleven than three.