GlaxoSmithKline Passes This Key Test

There's no foolproof way to know the future for GlaxoSmithKline (NYSE: GSK) or any other company. However, certain clues may help you see potential stumbles before they happen and before your stock craters as a result. Rest assured: Even if you're not monitoring these metrics, short-sellers are.

A cloudy crystal ball
I often use accounts receivable (AR) and days sales outstanding (DSO) to judge a company's current health and future prospects. It's an important step in separating the pretenders from the market's best stocks. Alone, AR the amount of money owed the company and DSO days worth of sales owed to the company don't tell you much. However, by considering the trends in AR and DSO, you can sometimes get a window onto the future.

Sometimes, problems with AR or DSO simply indicate a change in the business (like an acquisition), or lax collections. However, AR that grows more quickly than revenue, or ballooning DSO, can also suggest a desperate company that's trying to boost sales by giving its customers overly generous payment terms. Or it can indicate that the company sprinted to book a load of sales at the end of the quarter, like used-car dealers on the 29th of the month. (Sometimes, companies do both.)

Why might an upstanding company like GlaxoSmithKline do this? For the same reason any other company might: to make the numbers. Investors don't like revenue shortfalls, and employees don't like reporting them to their superiors. Is GlaxoSmithKline sending any potential warning signs? Take a look at the chart below, which plots revenue growth against AR growth, and DSO:

The standard way to calculate DSO uses average accounts receivable. I prefer to look at end-of-quarter (EOQ) receivables, but I've plotted both above.

Watching the trends
When that red line (AR growth) crosses above the green line (revenue growth), I know I need to consult the filings. Similarly, a spike in the blue bars (DSO) indicates a trend worth worrying about. As another reality check, it's reasonable to consider what a normal DSO figure might look like in this space.

Differences in business models can generate variations in DSO, so don't consider this the final word ust a way to add some context to the numbers. But let's get back to our original question: Will GlaxoSmithKline miss its numbers in the next quarter or two? I don't think so. AR and DSO look healthy. For the latest fully reported fiscal quarter, GlaxoSmithKline's year-over-year revenue grew 0.8%, and its AR dropped 1.1%. That looks OK. End-of-quarter DSO decreased 1.9% from the prior-year quarter. It was up 3.7% versus the prior quarter. Still, I'm no fortune-teller, and these are just numbers. Investors putting their money on the line always need to dig into the filings for the root causes and draw their own conclusions.

What now?
I use this kind of analysis to figure out which investments I need to watch more closely as I hunt the market's best returns. However, some investors actively seek out companies on the wrong side of AR trends in order to sell them short, profiting when they eventually fall. Which way would you play this one?

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