Pharmaceutical stocks such as GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) are viewed a lot differently by investors these days than they were 15 years or so ago.
Back then, they were considered high-growth stocks and attracted risk-takers who wanted to see their investment multiply, albeit with the risk of the company crashing and burning due to unfavourable FDA decisions or negative drug trials.
Today, pharmaceuticals are viewed as much more stable, high yield and limited growth companies. Indeed, they no longer enjoy the kind of earnings growth rates that they used to, with GlaxoSmithKline, for instance, forecast to deliver earnings per share (EPS) growth of 7% over the next year.
This may seem a little disappointing. But when you consider that GlaxoSmithKline currently trades on a price to earnings (P/E) ratio of 13.4, it translates into a price to earnings growth (PEG) ratio of 1.92.
Of course, this in itself may not seem so exciting, with a PEG ratio of 1 being seen as the ‘sweet spot’ of growth investing. However, with the FTSE 100 currently on a PEG ratio of closer to 2.5, as a result of sluggish growth prospects, and a P/E of 15.8, GlaxoSmithKline starts to look relatively good value.
In fact, if GlaxoSmithKline were to trade on a PEG of somewhere between its current figure and that of the FTSE 100 (say 2.2), it would mean that shares would be priced at around 1880p. This is just under 15% higher than the current share price and would, nevertheless, still mean that GlaxoSmithKline trades on a lower PEG than the wider market.
In my view, this share price increase is entirely possible, since GlaxoSmithKline continues to benefit from far higher barriers to entry than the run-of-the-mill FTSE 100 company. Although patents eventually expire, GlaxoSmithKline continues to enjoy a strong pipeline of drugs and this looks set to enable the business to maintain margins and deliver the earnings growth figures that the market is anticipating over the medium to long term.
Furthermore, with shares currently offering a yield of 4.8%, total profit of 20%+ could be on the cards for more patient investors.
So, GlaxoSmithKline’s shares still appear to be good value based on a PEG ratio of 1.92 — especially when it’s compared to the market, and when the high entry-barriers that GlaxoSmithKline benefits from are taken into account. A gain of 15% over the medium to long term looks to be achievable, with a dividend yield of 4.8% meaning total returns could exceed 20%.
> Peter owns shares in GlaxoSmithKline. The Motley Fool has recommended GlaxoSmithKline.