Is GlaxoSmithKline plc A Promising Capital-Growth Investment?

Some firm’s growth is more sustainable than others. What about GlaxoSmithKline plc (LON: GSK)?

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

sdf

gskIf we look at the immediate earnings’ growth forecasts for pharmaceutical giant GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US), it’s easy to conclude that the firm isn’t much of a promising capital-growth investment. Easy, but top-of-the-head analysis might be too simple.

City forecasters following the firm expect earnings to fall 15% in the current year to December followed by a 6% recovery during 2015. Those figures come on top of virtually flat earnings in 2012 and 2013 to paint an uninspiring picture on growth.

In fact, earnings were 20% higher in 2009 than they are likely to be in 2015, so we see real decline over the medium term, not growth of any kind at all.

But the share price has risen

However, GlaxoSmithKline shares were trading at about 1000p at the beginning of 2009 before rising to just under 1800p during 2013 and then falling back to today’s 1382p. So, the shares have indeed provided investors with capital growth over the period despite the decline in the business. So why does the share-price and business performance disagree?

I think that three factors might have conspired to produce this, perhaps, baffling outcome, but it is the third factor that might confound investor expectations on capital growth the most, going forward.

Three share-price drivers

Firstly, the firm has kept up dividend progression over the period, regardless of its lacklustre performance on earnings’ and cash generation:

Year to December 2009 2010 2011 2012 2013
Dividend per share 61p 65p 70p 74p 78p

Those valuing the business by reference to dividend yield might have been happy to keep buying. Even now, the shares yield about 6.1% on a forward basis.

Secondly, speculation has likely driven the share price. The thinking maybe goes ‘earnings’ recovery follows earnings’ decline’. GlaxoSmithKline often talks about the next generation of drugs and treatments it is developing to fill the earnings’ hole left as existing formulations lose their exclusivity. Then there’s the takeover fever swirling around the industry that Pfizer‘s pitch at AstraZeneca has whipped up to frenzied proportions.

Thirdly, and perhaps worthy of most focus right now, the valuations of traditionally defensive shares such as GlaxoSmithKline tend to move counter to the wider economic cycle. Companies seen as defensive, with reliable income streams whatever the financial weather, are most appealing to investors in volatile economic times, such as recently. When that happens, investors tend to buy and the valuation of the defensives rises.

However, it’s another cycle. So, when economic conditions seem more benign, investors switch to risk-on thinking and abandon stodgy old defensives in favour of more exciting investments, which causes the valuations of the defensives to fall.

Naturally, that’s an imperfect model, but it is an effect to watch that could drag on forward investor capital gains. There’s some evidence that valuation compression might be taking place right now, as the P/E rating was running at around 16 last year, which compares to about 14.5 today. Although it’s unclear how much of that effect results from reduced earnings’ expectations and bid speculation, and how much relates to valuation-cyclicality.

Growth is growth

Whatever the behaviour of shares, underlying business growth is growth. For a decent growth investment, we want to see forward earnings rising steadily. If the business is growing, the shares will take care of investors’ capital growth in the end.

With GlaxoSmithKline, we don’t have anyone forecasting growth figures, but we have a lot of jam-tomorrow talk. So, I think I’d better place my capital-growth money elsewhere.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Kevin Godbold has no position in any shares mentioned. The Motley Fool recommends GlaxoSmithKline.

More on Investing Articles

Finger clicking a button marked 'Buy' on a keyboard
Investing Articles

Analysts have upgraded this FTSE 100 stock to Buy. What should investors do?

Associated British Foods shares have been uninspiring for some time. But is it finally time to consider buying the FTSE…

Read more »

Man changing battery on electric bicycle
Investing Articles

Prediction: in 12 months the sizzling National Grid share price could turn £10,000 into…

It's been another solid year for the National Grid share price and the dividend yield is decent too. So why…

Read more »

Businessman using pen drawing line for increasing arrow from 2024 to 2025
Investing Articles

Up 185% in 3 years, why does the market love this FTSE 250 stock

Over the past three years, this stock has vastly outperformed the FTSE 250. Dr James Fox takes a closer look…

Read more »

A handsome mature bald bearded black man in a sunglasses and a fashionable blue or teal costume with a tie is standing in front of a wall made of striped wooden timbers and fastening a suit button
Investing Articles

Looking for growth, dividends, or value? These 3 ETFs could be smart ideas to consider

Exchange-traded funds (ETFs) provide a way for investors to spread risk without sacrificing the possibility of huge long-term returns.

Read more »

Happy couple showing relief at news
Investing Articles

Is the Rolls-Royce share price fast becoming a joke?

The FTSE 100 engineering titan has done brilliantly in recent years. But our writer wonders whether the Rolls-Royce share price…

Read more »

Middle-aged white male courier delivering boxes to young black lady
Investing Articles

Is there a ‘best age’ to start buying shares?

Christopher Ruane weighs some possible pros and cons of waiting to start buying shares for the first time, versus starting…

Read more »

piggy bank, searching with binoculars
Investing Articles

Is it time to look again at the FTSE 250’s worst performers?

Our writer considers the prospects for two of the worst-performing shares on the FTSE 250, with falls of at least…

Read more »

A handsome mature bald bearded black man in a sunglasses and a fashionable blue or teal costume with a tie is standing in front of a wall made of striped wooden timbers and fastening a suit button
Investing For Beginners

Down over 40% in the past year, I think investors should consider these value shares

Jon Smith points out two value shares that have fallen heavily over the past year but are starting to look…

Read more »