As analysts expect Essentra plc (LSE:ESNT) to record triple digit earnings growth over the next year, let’s stop and evaluate this promising sentiment. Investors should consider the forces that are causing this growth, as there are certain implications that can impact on shareholder return. To get a preliminary understanding, I will shine a light on the behaviour of Essentra’s margins to assist in analysing the revenue and cost anatomy behind the earnings expectations for the future and the impact it has on shareholder returns relative to the wider industry.View our latest analysis for Essentra
What does ESNT’s profit margin tell us?
At a high level, a company’s ability to earn on their sales efforts can play an important role in determining shareholder value. Knowing the portion of top line revenue that is turned into net income helps to assess this ability whilst spotting profit drivers, and can be found by calculating ESNT’s profit margin.
Margin Calculation for ESNT
Profit Margin = Net Income ÷ Revenue
∴ Profit Margin = 4.00 Million ÷ 1.03 Billion = 0.39%
There has been a contraction in Essentra’s margin over the past five years, due to 10.65% in average revenue growth and decline in net income of -20.74% on average, which means that although revenue has increased, a smaller portion falls in to the bottom line. The current 0.39% margin seems to continue this movement, indicating the earnings decline has been driven through an increase in costs as opposed to a reduction in revenue.
Understanding what could be driving Essentra’s future earnings
It is expected that margins will move from contraction into expansion, with 2.16% in expected annual revenue growth and annual net income growth forecasted at 34.68%. This suggests the previous earnings decline is expected to reverse due to enhanced cost efficiency alongside revenue increases. But as a result of improved cost efficiency, net income growth is expected to exceed revenue growth, which is causing the expectation for margins to expand. Nonetheless, investors should realise a expanding margin can mean different things for different companies, thus more detailed research is essential. In many situations, looking at a company’s profit margin in relation to other similar businesses can be more informative. In Essentra’s case, profit margins moving forward are forecasted to expand along with the margins in the Chemicals industry, whilst at the same time, the industry’s forecasted ROE of 15.77% exceeds that of the expected 7.68% ROE for ESNT. This suggests that analysts expect Essentra’s return per dollar of equity will lag behind the industry as a result of the earnings attributes identified by our margin analysis. However, margins use items on the income statement that are prone to being manipulated by various accounting measures, which can distort our analysis. Thus, it is essential to run your own analysis on Essentra’s future earnings whilst maintaining a watchful eye over the sustainability of their cost management methods and the runway for top line growth.
For ESNT, I’ve put together three essential aspects you should further research:
- Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Valuation: What is ESNT worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether ESNT is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of ESNT? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!