Does EKF Diagnostics Holding plc have more upside than GlaxoSmithKline plc after beating expectations?

Should you buy EKF Diagnostics Holding plc (LON: EKF) instead of GlaxoSmithKline plc (LON: GSK)?

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Point of care business EKF Diagnostics (LSE: EKF) has risen by over 5% today. This sharp hike in its share price is due to a positive update which shows that it has beaten expectations for the 2016 financial year. Looking ahead, the company has significant growth potential and could continue to rise in value. But is this sufficient to make it a better buy than healthcare peer GlaxoSmithKline (LSE: GSK)?

A strong end to the year

The fourth quarter was a very impressive period for EKF. Trading in the latter part of the year was materially better than budget. This means that the company’s performance will beat the figures provided in the trading update released in November. Specifically, revenue in excess of £38m has been achieved, versus previous guidance of at least £36.5m. Adjusted EBITDA (earnings before interest, tax, depreciation and amortisation) comfortably exceeded previous guidance of at least £5.5m.

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Encouragingly, the better than expected performance was entirely due to organic growth. This shows that the strategy employed is proving successful and could deliver further growth over the medium term. Additionally, cash generation during the fourth quarter was also strong, with EKF being net cash positive by the end of the year. It expects to remain so during the first quarter of the new year and will use some of the cash generated in 2016 to reduce its debt pile by around £1.6m. This puts it on a firmer financial footing through which to deliver further growth in future.

Outlook

Following four years of losses, EKF’s move into profitability in 2016 is a big step forward for the business. It shows that it has the potential to deliver strong returns for its investors and looking ahead, impressive growth is on the cards. For example, in 2017 earnings are due to rise by 38%. This puts it on a price-to-earnings growth (PEG) ratio of only 0.7, which means that capital gains are on the horizon.

This growth rate is easily ahead of that of GlaxoSmithKline. The healthcare major is expected to record a rise in its bottom line of 10% in 2017. With it trading on a PEG ratio of 1.4, it lacks the exceptionally low valuation of EKF but remains good value for money nonetheless. A key reason for this is that GlaxoSmithKline is a highly diversified business with a wider economic moat, greater diversity and far lower risk than EKF. Therefore, it demands a higher valuation.

In terms of which stock could deliver the greatest gains for its investors, EKF clearly has the scope to double and remain good value for money. However, at the same time it’s more likely to endure a difficult period than its larger peer thanks to its higher risk profile. As such, GlaxoSmithKline remains the better buy based on risk and reward, although EKF could prove to be a star performer in 2017 and beyond.

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Peter Stephens owns shares of GlaxoSmithKline. The Motley Fool UK owns shares of and 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.

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