Institutional investors don't blindly believe the things the companies they follow tell them. “Trust but verify” is one of the adages they live by… so one key aspect of their job is to corroborate the information you provide – using their findings to drive their earnings estimates. Therefore, providing verifiable and quantifiable commentary to back up your guidance is critical in gaining trust and respect from the investment community. Does your investor relations specialist or IR consulting firm regularly advise you to provide this type of guidance?
While every company is unique, there are a lot of similarities in how businesses work across industries. In general, investors like to think in the lowest-common-denominator across as many companies as they can and tend to frame up businesses in a way they can understand. This often approximates a formula that looks like this:
Number of units sold x Average selling price per unit = Revenue
Maybe your business doesn’t fall into exactly this category, or perhaps you have another variable to consider like yield, churn, or net retention. If that’s the case, make sure your investors and the publishing analysts who cover your stock fully understand each of the drivers for your specific formula.
Why is this important? Because for investors to feel comfortable owning your stock, they need to be able to go out into the field and perform primary research. Doing so will allow them to decide if they think your growth projections make sense. They will make a judgment about whether your outlook is realistic, conservative, or too aggressive, and this will drive their decision-making on the stock.
To illustrate this concept, consider two companies. One says,"with our new product launching this quarter, we predict we'll grow 20% this year and 15% the next."
The other says,"our new product, which is launching this quarter, has the potential to add 1,500 to 2,000 basis points of incremental growth to our existing base of revenue over the next two years. We assume a selling price of $X and a Y% market penetration of our existing customer base to make this prediction."
Which company would you find more believable? To which company would you allocate your precious time in order to perform field research? Even if you could perform field research on the first company, what would you ask for your sources? Obviously, the second company is likely to have more credibility, since analysts can talk to customers, competitors, and resellers and ask, “what price is the product selling for” and “what kind of penetration is it achieving in the existing customer base?” The easier it is for investors to verify the health of your business, the more likely you’ll be to develop a “sticky” investor base.
Conversely, if these "channel checks" are impossible or worse, don’t back up your claims, investors will conclude your statements are untrue and your credibility will be damaged. Stock multiples suffer when management’s credibility is in question.
Having an experienced investor relations officer on your staff or using an IR consulting firm can help you articulate your business through a series of realistic and believable statements. If you remember that everything you say to the investment community will be scrutinized (including what you say at investor conferences), you’ll realize that it pays to take the extra step in providing as much detail as possible regarding how you plan to achieve your numbers.