Understanding profit warnings

Julie Palmer

Regional Managing Partner

3 Minutes to read

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Understanding profit warnings

Updated: 5th February 2020

Taking Heed of Profit Warnings

RBR Advisory partner, Julie Palmer, explains what events typically lead up to a company issuing a profit warning, and why a company would publicly declare a period of poor trading performance.

Profit warnings are issued by companies when they’re aware their earnings outlook or upcoming profit level will be lower than that forecast by the market. City analysts track companies listed on the stock exchange and receive briefings from company executives on the organisation’s performance, projecting earnings, and profit figures based on this information.

The reason this is done is because it is an offence to create a false impression of a company’s performance and it’s imperative to correct misleading information or forecasts that have been issued to investors and the general public.

If company executives know their profits won’t be as high as those forecast by the analysts, therefore, it must be publicly disclosed to shareholders and the stock market by way of a profit warning statement. The reasons why a profit warning has been announced should also be provided.

The implications of profit warnings for businesses and investors

Investors typically use a company’s earnings outlook and profit forecasts to guide their investment decisions, so the implications of a profit warning for both businesses and investors can be significant.

Profit warnings are typically announced towards the end of a financial period – perhaps two or three weeks prior to the issue of a new earnings outlook. When provided at this time they offer analysts and investors the opportunity to modify their expectations of the company’s performance.

"Profit warnings are issued by companies when they’re aware their earnings outlook or upcoming profit level will be lower than that forecast by the market."

Common consequences of issuing a profit warning

Company share prices generally fall following a profit warning so timing the announcements well can prepare the market for the adverse results, potentially lessening the negative effect on share prices.

Sometimes profit warnings are announced late on a Friday afternoon, for example, so those active in the stock market are unable to trade straight after the profit warning statement has been made.

The fact remains, however, that the value of a business does fall significantly when a profit warning is issued whatever the time of day, and in reality there is little the company can do to minimise those effects.

Reasons for making a profit warning

The reasons why a company announces a profit warning can vary, and may either be provided in detail or with minimal explanation. Some businesses might attribute a single adverse event for causing the lower than anticipated profits – the loss of a major customer, for example, while other companies will point the blame at macroeconomic or global political issues.

Other companies could choose to provide shareholders and other interested parties with a detailed account of the factors that have resulted in the profit warning, such as sales figures and profit margins, or problems within the supply chain.

How are profit warnings issued by companies?

A business will typically issue a profit warning by way of a press release, but sometimes company executives will announce profit warnings to analysts directly via conference calls.

They may try to avoid a significantly adverse market reaction to their news, and as we mentioned earlier, could decide to announce the profit warning as the stock markets close down for the weekend.

It’s also possible that potential shareholder litigation could be a factor in the timing of a profit warning, as shareholders may decide to take action if the company doesn’t announce bad news in a timely manner.