MENU

At What Price Would GlaxoSmithKline plc Be A Bargain Buy?

gskPatience is one of the key attributes of a successful investor. The likes of US master Warren Buffett have been known to wait years for the right company at the right price.

Now, while buying stocks at a fair price will tend to pay off over the long term, we all love to bag a real bargain.

Today, I’m going to tell you why I believe GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) is currently in the bargain basement.

Historical valuation

Glaxo Wellcome and SmithKline Beecham merged in December 2000. The group released its first set of results as GlaxoSmithKline in February 2001, reporting pro forma earnings per share (EPS) of 61p.

In the following five months, before the interim results in July, GSK’s shares traded at an average price of 1,900p, giving a price-to-earnings (P/E) ratio of 31.

There was a long de-rating of the shares through the Noughties, which reached bottom with the financial crisis/bear market, and concerns about a forthcoming industry-wide ‘patent cliff’ that would see exclusivity expire on some of the world’s biggest money-spinning drugs.

Between March and May 2009, GSK’s shares traded at an average price of 1,036p, with a P/E of just below 10 on EPS of around 105p.

Patent expiries have taken their toll over the five years since. EPS has fallen from 105p to 99p, and is expected to bottom out this year at 95p. Nevertheless, the shares have risen 34% to 1,392p.

Thus, the share price increase has been driven not by EPS growth but by a rising P/E: from just below 10 in the spring of 2009 to over 14 today, as the market has become increasingly confident of GSK weathering the patent cliff and returning to earnings growth.

What price for a bargain buy today?

If we say GSK at a P/E of 10 with a share price gain of 34% over the five following years was a bargain buy, what would the company have to do over the next five years to deliver a similar return?

Well, assuming the current P/E stays the same — it seems an eminently fair rating to me — EPS would have to rise from the current-year forecast 95p to 127p five years out.

Such a rise would represent a compound annual growth rate (CAGR) of 6%. During GSK’s last growth phase — 2001-09 — the CAGR was 7%. On this basis, I reckon the shares are a bargain buy at their current level of under 1,400p.

Another take on valuation

Stephen Lamacraft, one of the team on the new fund of ace investor Neil Woodford, has recently given an interesting take on GSK’s valuation.

He reckons GSK is worth around one-and-a-half times its current market value, with the company’s consumer healthcare business representing half the market cap, if rated on the same seven times sales valuation Bayer recently paid to acquire the consumer healthcare business of Merck.

He concludes: “Now, we are not suggesting that a corporate bidder is going to pay that sort of money for Glaxo’s consumer healthcare business any time soon — it’s just an interesting way of looking at the valuation opportunity that exists in the stock currently”.

Finally, if you already have GSK tucked away in your portfolio and are in the market for more great blue-chip shares, I recommend you help yourself to this FREE Motley Fool report.

You see, the Fool's top analysts have identified five companies -- one of which is GSK -- that they believe will deliver superior long-term growth in earnings and dividends. Such is their conviction about the quality of these businesses that they've called the report "5 Shares To Retire On".

This free report comes with no obligation -- simply click here.

G A Chester has no position in any shares mentioned. The Motley Fool 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.