Is GlaxoSmithKline Pharmaceuticals Limited's (NSE:GLAXO) Recent Performancer Underpinned By Weak Financials?

It is hard to get excited after looking at GlaxoSmithKline Pharmaceuticals' (NSE:GLAXO) recent performance, when its stock has declined 2.9% over the past three months. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Specifically, we decided to study GlaxoSmithKline Pharmaceuticals' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for GlaxoSmithKline Pharmaceuticals

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for GlaxoSmithKline Pharmaceuticals is:

5.1% = ₹932m ÷ ₹18b (Based on the trailing twelve months to March 2020).

The 'return' is the yearly profit. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.05 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of GlaxoSmithKline Pharmaceuticals' Earnings Growth And 5.1% ROE

It is quite clear that GlaxoSmithKline Pharmaceuticals' ROE is rather low. Even compared to the average industry ROE of 12%, the company's ROE is quite dismal. As a result, GlaxoSmithKline Pharmaceuticals' flat earnings over the past five years doesn't come as a surprise given its lower ROE.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by16% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if GlaxoSmithKline Pharmaceuticals is trading on a high P/E or a low P/E, relative to its industry.

Is GlaxoSmithKline Pharmaceuticals Making Efficient Use Of Its Profits?

GlaxoSmithKline Pharmaceuticals has a high three-year median payout ratio of 80% (or a retention ratio of 20%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.

Additionally, GlaxoSmithKline Pharmaceuticals has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 60% over the next three years. The fact that the company's ROE is expected to rise to 33% over the same period is explained by the drop in the payout ratio.

Conclusion

Overall, we would be extremely cautious before making any decision on GlaxoSmithKline Pharmaceuticals. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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