What Do Expectations Tell Us About GlaxoSmithKline plc's (LON:GSK) Margins In The Future?

With analysts forecasting GlaxoSmithKline plc (LSE:GSK) to report triple digit earnings growth in the coming 12 months, it's important to take a step back and think through this promising sentiment. Those invested in the stock should contemplate the factors that are causing this projected increase, as the return realised by shareholders may look different in the future if underlying assumptions are not realised. To help investors get a top level understanding, I will try to evaluate GlaxoSmithKline's margin behaviour 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.

Check out our latest analysis for GlaxoSmithKline

Breaking Down GSK's Profit Margin

Attractive margins generally indicate a desirable ability to translate sales revenue in to earnings, and return for shareholders. 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 GSK's profit margin.

GlaxoSmithKline's margin has contracted in the past five years, due to postive average revenue growth of 0.34% and decline in net income of -7.07% on average, which suggests that a smaller percentage of revenue falls to the bottom line despite the fact revenue has increased over the previous 5 years. The current 5.08% margin seems to continue this movement, which suggests that the decrease in earnings has arisen due to difficulties in managiong costs as opposed to a lack of top line revenue.

What does GlaxoSmithKline's margin expectation tell us about future earnings?

Based on future expectations, GSK's profit margin will move from contraction into expansion, with 2.66% in expected annual revenue growth and annual net income growth forecasted at 22.42%. 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. Despite this, those watching the stock must know margin expansion has different impacts on profit and return depending on the underlying situation, which reinforces the importance of deeper research.

Generally, it is useful to judge profit margin and its implication on return in comparison to other companies who share similar traits. For GlaxoSmithKline in particular, profit margins moving forward are forecasted to expand along with the margins in the Pharmaceuticals industry, whilst at the same time, the forecasted ROE of GlaxoSmithKline is greater than the industry at 432.75% and 11.19% respectively, although it must not be forgotten than this result is influenced by the company's debt levels. This suggests that analysts expect GlaxoSmithKline's return per dollar of equity will exceed the industry due to the earnings attributes identified in 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 GlaxoSmithKline's future earnings whilst maintaining a watchful eye over the sustainability of their cost management methods and the runway for top line growth.

Next Steps:

For GSK, I've compiled three pertinent factors you should further examine:

1. 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.
2. Valuation: What is GSK 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 GSK is currently mispriced by the market.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of GSK? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.