Should You Follow Warren Buffett And Dump GlaxoSmithKline plc?


It was recently revealed that Warren Buffett, widely considered to be one of the world’s best investors, had sold off his entire shareholding in GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US).

While it is true that Glaxo was never a huge holding for Buffett, amounting to less than 0.1% of the investment managers’ portfolio, we should try and establish why Buffett made this move and whether or not you should be concerned.

Glaxo has been underperforming

One the reasons behind Buffett’s sale, could be do with Glaxo’s poor performance during the past few years. In particular, due to the loss of exclusive manufacturing rights for a number of key treatments, Glaxo’s revenue, operating income and earnings per share have all ticked lower during the past five years. Unfortunately, over the same period, many of Glaxo’s international peers have reported rising sales and earnings.

In addition, Glaxo’s debt has been rising faster than that of its peers during the same period. For example, at present Glaxo’s net debt to equity ratio currently stands at around 200%. Meanwhile, the average net debt to equity ratio of the company’s international peers, including Pfizer, Sanofi and Johnson & Johnson is less than 50%. 

But above all…

However, Buffett’s biggest concern could be to do with Glaxo’s management team. You see, Buffett only likes to invest in companies with strong management teams and more importantly, management teams that can be trusted. Sadly, recent mistakes, particularly within China, have proven that Glaxo’s management team cannot be trusted.

Specifically, Glaxo’s management team broke Chinese bribery the laws to encourage sales of their treatments. This has dented the company’s sales and reputation within what is becoming the most important market in the world for many companies. To be precise, Glaxo’s sales within China collapsed 60% during one quarter alone last year. In comparison, peers such as London-listed AstraZeneca have seen sales in China jump. Glaxo’s rising debt and sliding sales are further indications that management could have made some mistakes.

Actually, Buffett has previously made it clear that he will dispose of his holding in companies with managements that have failed shareholders. Indeed, the world most prolific investor sold his holding of international drugs giant Johnson & Johnson several years ago citing that, “there had just been too many mistakes”.

Should you follow Buffett’s move?

But the key question is, should you follow Buffett and dump your holding in Glaxo? Well, investors need to trust company management teams to run business well on their behalf and Glaxo’s management has proven that it can’t be trusted.

That being said, Glaxo is well positioned for growth over the next few years. The company has a with a strong treatment pipeline and sales growth within China should pick up in the long-term. So, as of yet, despite mistakes within China, I wouldn’t follow Buffett’s move to offload Glaxo just yet. 

If you think otherwise

Glaxo is best known for its defensive nature and dependable dividend payouts and for the time being, this looks set to continue. However, if, like Buffett, you no longer trust Glaxo's management then perhaps it's time to look for a company that can take the place of Glaxo in your portfolio.

To help you analyze potential candidates, The Motley Fool's analysts have put together this free report, which outlines all the key facts you need to consider when selecting dividend stocks for your portfolio.

Click here to download your no obligation free report today! 

> Rupert does not own any share mentioned within this article. The Motley Fool has recommended shares in GlaxoSmithKline.