Profitwarning

Key Takeaways

• A profit warning occurs when a company advises that its earnings will not meet analyst expectations before the official earnings results.
• Companies issue profit warnings to soften the impact on investors and allow the market time to adjust before the official announcement.
• Poor performance, business cycle downturns, or industry challenges can lead to profit warnings, affecting investor perceptions and market value.
• Profit warnings usually precede detailed earnings announcements, offering insights into financial challenges and adjustments.

What Is a Profit Warning?

A profit warning is a company-issued note stating that its earnings won't meet previously expected levels. It's a preemptive announcement ahead of an official earnings report, giving the market time to adjust expectations and helping companies manage potential investor reaction and market impact. They often signal underlying business challenges or shifts in financial performance, so understanding them can help you make important investment decisions. Keep reading to learn more about profit warnings, why companies issue them, and what they mean for investors.

Understanding Profit Warnings in the Market

A company usually announces a profit warning two or more weeks before an earnings announcement. Some companies do this to soften the blow to investors, allowing both them and the market as a whole more time to adjust accordingly. This ideally takes some of the sting out of the expected price adjustment. If a company does not issue a profit warning, its earnings announcement is called a negative earnings surprise.

A profit warning may occur if the company is in a down business cycle; however, since this event is more expected it is often due to poor performance or a single challenging incident either internal to the company or external from the industry or business environment.

During a profit warning the company might mention issues related to key growth drivers like sales and margins, its supply chain, new customers, and more. As with regular earnings reports, a profit warning can get into granular detail or can remain more general, noting only a few places in its financial statements where its performance could fall below what shareholders anticipate.

Case Study: Capita's 2018 Profit Warning

One of the largest outsourcing companies in the U.K., Capita, issued a profit warning in January 2018, noting it had not been awarded any central government contracts. (Capital supplies a wide variety of public services, including assessments for disabled benefit claimants, electronic tagging for offenders, facilitating the administration of teachers’ pensions and more.) The announcement erased £1 billion off its market capitalization in a single day.

While Capita had received contracts from the BBC and Northern Ireland authorities, its lack of government contracts represented a large gap in a major source of revenue. The company also noted a pre-tax loss of £535 million in 2017, which was up from £90 million in 2016.

How Profit Warnings Impact Earnings Announcements

Following a profit warning usually comes the company’s official earnings announcement. The format of this is often a call with management that shareholders and the public may dial into. A company’s investor relations team subsequently publishes a transcript of this call, including questions and answers from those listening in.

If the earnings announcement follows the profit warning, it will often expand upon the reasons for the miss in expectations – particularly in the management discussion and analysis (MD&A) section.

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