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PROFIT WARNING

Profit Warning

Listed companies declare a warning to its investors that the company will be witnessing a decline in profits in the upcoming year or it may even make losses. Such a warning declaration by the public listed companies is known a profit warning. 

The company announces that due to unforeseen circumstances it will be not reaching its anticipated profit limits and ask the shareholders to be prepared for the news. This announcement is usually two week before the earnings announcement. In a way it softens the blow on the investors and brings down volatility of the stock. The profit warning is not as detailed as actual earnings report. In profit warning, the gist of growth estimates going wrong and not meeting expectations are announced where as in earnings report the minute details related to company’s financials are reported.

Significance of profit warning

The reason for the profit warning might be company being in down business cycle. Poor performance of the company can be because of an unexpected challenging incident either inside the company or in the industry where company operates. It is proven fact that the stock price rise significantly during the earnings announced dates. Thus any deviation from estimated earnings greatly affects the stock price if profit warning is not done.

Due to unforeseen situation in an economy or sudden change in policy, the profitability of the companies in that economy will be hampered. In such scenarios companies are bound to announce profit warning. Before the year 2000, companies were legally obligated to communicate their estimates earnings to certain chosen analysts. Now the sec makes it mandate to communicate profit warning to both public and analysts at the same time. Regulatory authorities can issue notice and take legal action against firms who have not announced profit warning even when they were supposed to, in case of not meeting the estimated earnings.

Examples of profit warning

1. In the year 2018 January, UK’s largest company “Capita” issues profit warning to public. The company anticipated the central government contracts to roll in its favour and had estimated higher significant growth. The stock has appreciated in UK market due to this estimation. After the announcement of profit warning, market cap of company was erased by 1 Billion Euros on a single day. Even though the firm has received contracts from few private firms, missing out on the expected government contracts resulted in 535 Euros losses for that particular year. Stock price fell from 363 GBX to 162 on January 2018. It is currently trading at 165 GBX in London stock exchange.

2. On October of 2018, US agro business giant Bunge announced another profit warning. Due to the trade war between USA and China instigated by Trump’s president’s rule, China has increased tariff on agro import from US companies. This has increased the price of products manufactured by companies by Bunge. The company is expecting its earnings before tax and interest (EBITDA) to be cut by 1 Billion USD compared to previous year. As the company was lowering its expected earnings each quarter, stock fell from 67 USD to 52 USD in NYSE.


Impacts of Profit warning.

• Whenever analysts are trying to predict the stock price in the market, usually they forecast the financials of the company. They assume the growth rate as per the announcements previously done by company management and arrive at a target price. Based on this target stock price they advise the investors to buy/sell shares in market. 

• According to the demand the price fluctuate in the stock exchanges. During the profit warning announcement, the company communicates the decrease in expected earnings to these analysts, it also states by what extent they will not be able to reach the expectations. Then the analyst forecast the new financials in their report accordingly and arrive at new stock price.

• Analysts influence stock volatility significantly, when communication done in timely manner will reduce the matter of shock and panic among the investor and support the stock price to the actual price. 

• Usually the earnings are report two weeks after the profit warning announcement is done. If earnings are lesser than the estimated earnings and profit warning is not announced, share price will fall drastically due to panic and shock. The shareholders wealth will be depleted significantly. To substantiate this SEC has put such regulation to make profit warning public in such cases.

• To avoid or reduce the legal liability in case of management earning estimate going wrong, few companies chose not to announce the profit warnings, these firms do not provide guidance to analyst to estimate and forecast their financials also. Stock prices of such companies often break and analyst blame on company’s non-availability profit warning or guidance.

• During the profit warning, company communicate key issues pertaining to its growth estimates like sales, margins, new clients, new projects, expansion plan, and business policies so on. The reason for not meeting estimated earnings is explained and propagated to the public.

Conclusion

Companies usually issue profit warning two weeks before the earnings are announced. This is done asper regulation by SEC. The profit warning announcement reduces the blow it might have caused otherwise on the investors. The panic and shock factor is reduced and as a result, investor can be prepared for extreme measure. The volatility of stock if the profit warning is not issued will be high and can greatly decrease the shareholder’s wealth. If the information in the earnings announcement is equal to or greater than estimated earnings then obviously the stock performs very well and investor wealth appreciates. Problem arises when the earnings are not able to meet the estimated earnings, then it can come as a shock to shareholders and they will end up dumping stock into market. This in turn increases the supply against the demand and the stock price depletes further.  As a protection against this risk, the SEC in USA (regulatory authorities across globe) has put mandate on company to issue profit warning in case they are not able to meet their estimated earnings.


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