While shares in GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) have disappointed in the last year, it has not been the same story for a number of its pharmaceutical rivals. In fact, shares in Genus (LSE: GNS) and Dechra (LSE: DPH) have soared in the last 12 months by 35% and 55% respectively, which is a much healthier return than GlaxoSmithKline’s fall of 6%.
Does this mean, then, that Genus and Dechra are better buys that GlaxoSmithKline? Or, is their larger peer now better value for long term investors?
Margin Of Safety
Suffice to say, it is rare to find a pharmaceutical company that offers a wide margin of safety. That’s even more the case when comparing them to the wider market, since they tend to offer stronger growth in the long run, while their lack of strong correlation to the macroeconomic outlook marks them out as strong defensive plays. So, while all three companies trade at premiums to the FTSE 100, their margins of safety still differ somewhat.
For example, Genus and Dechra currently trade on price to earnings (P/E) ratios of 25.6 and 26.1 respectively, which are significantly higher than the FTSE 100’s P/E ratio of around 16. Certainly, both companies are set to increase their bottom lines at a much faster rate than the wider index, with growth of 16% in the current year and 12% next year pencilled in for Genus. Meanwhile, Dechra is expected to grow its profit by 8% this year and 11% in the following year.
The problem, though, is that these above average growth rates appear to be adequately priced in – especially after their aforementioned share price rises in the last year. As such, there is little margin of safety, which could mean that share price growth is not as impressive as the market is currently anticipating.
GlaxoSmithKline, of course, is lacking significant growth appeal over the next couple of years. In fact, its bottom line is forecast to fall by 4% this year before recovering by 3% next year. So, compared to Genus and Dechra, it is expected to post disappointing results. However, GlaxoSmithKline trades on a much lower rating than its two smaller peers, with it having a P/E ratio of just 16.8. This indicates that if the company is able to deliver on the efficiencies it has planned and which are set to catalyse its bottom line, its valuation has scope to move substantially upwards.
Of course, with sales and earnings of pharmaceutical companies being relatively volatile, an income element to total return can be highly worthwhile for investors. In this space, GlaxoSmithKline is the clear winner of the three companies, since it has a dividend yield of 5.3% at the present time. This compares favourably to Genus and Dechra, which have yields of just 1.4% and 1.6% respectively.
And, looking ahead, the total return from GlaxoSmithKline could be higher than that of Genus or Dechra, since it offers a much cheaper share price. And, from next year, it is expected to return to growth, which could act as a catalyst on investor sentiment. So, while Genus and Dechra have massively outperformed GlaxoSmithKline in the last year, the tables could turn for investors taking a long term view.
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Peter Stephens owns shares of GlaxoSmithKline. The Motley Fool UK has recommended GlaxoSmithKline. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.