Companies issue profit warnings to report an adverse impact on earnings for a period.
What Is a Profit Warning?
A profit warning is a statement issued by a company relating to risks of its earnings in a future period, be it a quarter or a year. When a publicly traded company announces a profit warning on its earnings performance, it may portend net income coming in below its own estimate or analysts’ consensus earnings estimate. It also could possibly post a loss.
The warning may be included in forward-looking statements such as in the management discussion and analysis section of the financial statement that is filed quarterly or annually with the Securities and Exchange Commission. Further, the profit warning could be issued separately in a press release. Subsequent to the public announcement, analysts are likely to adjust their earnings estimates and stock price targets to reflect the company’s profit warning.
Reasons for issuing a profit warning vary. A multinational oil company may say that earnings are likely to be down from the same reporting period a year earlier due to a force majeure at a major refining facility. An automaker may report that demand for its gas combustion-engine cars and trucks in the current fiscal year will be down as purchases for electric vehicles increase. A sudden downturn in the economy will depress consumer demand, hitting the returns of luxury goods makers.
After the onset of the COVID-19 pandemic in 2020, many companies warned of declining sales and profit as consumers stayed at home and held off on purchases. Manufacturers warned of disruptions to their supply chains, causing them to delay production.
How Does a Profit Warning Affect a Stock’s Price?
A profit warning is likely to cause a company’s stock to decline. Lower net income means an analyst covering the company’s stock will need to revise earnings forecasts, and that could lead to a cascade of other changes, such as an adjustment in the price-to-estimated-earnings ratio.
There is no regulation dictating a company’s obligation to warn investors of its profit being adversely affected for a period. But fair warning at least a few weeks’ time prior to the release of its earnings report might be deemed sufficient. That could give time for investors to decide whether to reduce their positions or wait. Still, investor reaction to a company’s stock will be immediate, by sending share prices lower.
However, the degree of severity of a stock’s decline depends on investor sentiment. A warning that sales and profit will be negatively impacted permanently, for example, could lead to a steep price decline.
It would serve in the best interest of a company to release information that might materially impact its earnings, and failure to do so might be perceived as an attempt to defraud investors under SEC rules. Hence, a reason for companies to publicly warn investors of their upcoming profit would be to avoid shareholder lawsuits.
What’s the Difference Between a Profit Warning and a Whisper Number?
A profit warning is a company’s published disclosure to the public that its earnings may not meet its own internal profit projections or analysts’ earnings estimates. A whisper number is an unofficial and unpublished earnings estimate that is informally released prior to the release of a company’s income statement.
