GlaxoSmithKline Pharmaceuticals Limited's (NSE:GLAXO) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

GlaxoSmithKline Pharmaceuticals (NSE:GLAXO) has had a rough three months with its share price down 17%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on GlaxoSmithKline Pharmaceuticals' ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for GlaxoSmithKline Pharmaceuticals

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

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

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

40% = ₹6.8b ÷ ₹17b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.40 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

GlaxoSmithKline Pharmaceuticals' Earnings Growth And 40% ROE

To begin with, GlaxoSmithKline Pharmaceuticals has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. As a result, GlaxoSmithKline Pharmaceuticals' exceptional 20% net income growth seen over the past five years, doesn't come as a surprise.

Next, on comparing with the industry net income growth, we found that GlaxoSmithKline Pharmaceuticals' growth is quite high when compared to the industry average growth of 13% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 92% (implying that it keeps only 8.1% of profits) for GlaxoSmithKline Pharmaceuticals suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Besides, GlaxoSmithKline Pharmaceuticals has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 52% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Summary

On the whole, we do feel that GlaxoSmithKline Pharmaceuticals has some positive attributes. Especially the growth in earnings which was backed by an impressive ROE. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be negligible. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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This article by Simply Wall St 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. Simply Wall St has no position in any stocks mentioned.