A company increases its risk of volatility and reduced valuations if it refuses to give guidance, says James Amoroso

This February, Unilever made the decision not to provide financial guidance for investors. And the share price crashed. Despite this, Unilever CEO Paul Polman claims many companies have since been telling him "I wish I could do that...".

Unilever actually re-introduced short-term guidance with its Q1 results - not specific targets, but detailed guidance for many drivers of the income statement. And the share price recovered.

While the recovery of the share price is a good thing, the price volatility that arose is unhealthy. Volatility increases investors' risk and reduces the valuation structurally. And share price volatility is as harmful on the way up as it is on the way down.

The real question is not whether to scrap guidance but how management can maintain the necessary operational flexibility, while giving investors what they need to make investment choices.

Short-term guidance can create an unhealthy straitjacket for management. But there is no conflict between long-term guidance and the operational needs of the business. After all, businesses are supposed to be run for the long term.

The share price is - or is supposed to be - the reflection of tomorrow's value in today's money. So who are best positioned to quantify a company's future, the insiders or the outsiders? The problem is often that management forgets analysts have to put numbers into spreadsheets and that these are used to generate a price target and an investment rating. Analysts use long-term guidance as a starting point and adjust its components up or down depending on their own assessment. Analysts then plot a trend backwards to the present. But what happens if no starting point is given?

The absence of company-endorsed, long-term guidance forces analysts to invent scenarios. Because the long term is unclear, it also encourages analysts to use shorter-term valuation methods.

Without long-term guidance, the share price is like a ship steering a course according to how the wind blows. What will happen to Unilever when the next storm breaks?

James Amoroso is a consultant in investment communication.