AstraZeneca is involved in the discovery, development, manufacture, and marketing of prescription pharmaceuticals primarily for the cardiovascular, gastrointestinal, neuroscience, oncology, respiratory and inflammation, and infection areas in the healthcare sector worldwide (AstraZeneca Plc Profile 2006). GSK is the major competitor of Astrazeneca as the former engages in the creation, discovery, development, manufacture, and marketing of pharmaceutical and consumer health-related products worldwide (GlaxoSmithKline Plc Profile 2006). In comparing the profitability of investing in these pharmaceutical companies, financial ratio analysis will be conducted.
Financial ratio analysis is a very essential tool in assessing the financial health of a business entity. It enables a financial analyst to spot trends in business and to compare it with the performance of similar business enterprises within the same industry. This tool is currently utilized by business managers, investors, creditors, suppliers, and other decision-makers in order to determine the financial performance and well being of a business organization. Financial ratios are grouped into five categories, each showing a different aspect of a company’s financial operations. These are profitability ratios, financial leverage ratios, liquidity/solvency ratios, efficiency ratios, and investor ratios.
2.1. Profitability Ratios
Profitability ratios measure the ability of the company to generate income from its investments less the costs incurred (Fraser amp. Ormiston 2004). Return on capital employed is a variant of return on investment. Return on capital employed (ROCE) is a measure of how well the company is utilizing its capital. The computed sales profit margin, which is the ratio of operating income to sales measures as a percentage of sales, the excess revenue from sales over cost of normal operation excluding financing. Asset turnover measures the number of sales generated by every pound in the company’s assets. Net profit margin, on the other hand, is the ratio of net income to sales showing the company’s ability to efficiently manage cost and turn its revenue into profits (Fraser and Ormiston 2006). Logically, higher performance ratios indicate a healthier financial condition.
At first look, it becomes apparent that GSK is more profitable than AstraZeneca. GSK reports higher return on capital employed, gross profit margin, and net profit margin from 2003-2005. AstraZeneca only manages to overtake GSK in asset turnover ratio during 2005, implying that the former is more efficient in utilizing its resources to generate revenue.
Looking at the ratios more closely, it can also be deduced that even though GSK shows higher profitability than Astrazeneca, this ability to make profits has been significantly declining over the years. From the ROCE of 78.28% in 2003, GSK’s performance has slumped attaining a ROCE of 38.06 last year.Gross profit margin and asset turnover have also dropped from 78.28% and 2.48 times to 76 .32% and 1.22 times for the three year period, respectively.