Is GlaxoSmithKline plc’s Opportunity AstraZeneca plc’s Threat?

AstraZenecaPharmaceutical companies are notoriously tricky businesses with massive reward potential; from patent legislation to pricing competitions, the road to medicinal gold is paved with an underlying risk that is beyond the grasp of most of us investors the majority of the time.

There are no two better examples of this fact than the case of GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) and AstraZeneca (LSE: AZN) (NYSE: AZN.US). Both Glaxo and AstraZeneca are major competitors in the pharmaceutical space: the latter has a market capitalisation of £70 billion, while AstraZeneca is only slightly smaller at £58 billion.

Which is why it’s awfully puzzling for investors to see that Glaxo is trading at 14.8 times earnings, down nearly 10% on the last one-year period, while AstraZeneca is going for 46.3 times earnings, ahead by almost 50% in value over the same period.

Go With Glaxo, or All-In On Astra?

Several analysts and a few Fools on our US sister site have suggested that this is because of Glaxo’s troubles in China last year, where senior executives were indicted for doling out bribes to beat local drug makers to the punch. Glaxo bulls claim that the company has better biotechnological competencies than its rival as a result of the 2012 purchase of Human Genome Sciences for $3 billion. Human Genome Science makes experimental treatments for Lupus, diabetes and heart disease. At such a cheap valuation, they say, it would be nuts to prefer AstraZeneca over Glaxo.

But these arguments are not entirely fair, and discount a significant amount of immediate value left in AstraZeneca. For a start, AstraZeneca does have some significant biotechnological competencies. Its giant $15.6 billion 2007 acquisition of MedImmune gave it access to a whole host of infant medicine patents developed the biotech route, and those of us with kids know all too well how big a market infant healthcare is.

What is more, recent attempts by US drug giant Pfizer to swallow up AstraZeneca have been a little too brazenly brushed off. (In May, Pfizer offered £55 a share for the London-based pharmaceutical company after it acquired Bristol Myers-Squibb’s diabetes business). Pfizer is still said to be ruminating another for offer now, and it knows where the lower limit is this time. Given that AstraZeneca will be up for play – legally speaking – in November, there may be a lot of short-term value here.

If you go back a year, and then compare performances of Glaxo and AstraZeneca, however, Glaxo wins hands down much the same way AstraZeneca wins so easily over the last year. During the September 2008-2013 period, Glaxo leaped 62.8% while AstraZeneca only showed 25.5% in gains. This is part of the rollarcoaster ride that is pharma investing.

Dope The Market Alternately

So how to play this scenario out? My advice is to purchase both companies, with a heavier weighting of 2-1 or even 3-1 in AstraZeneca. Once this stock looks like it’s ridden out most of the next six months’ gains, or if it hasn’t shown any substantial uplift further, I recommend switching that investment weighting to 2-1 in the favour of Glaxo to let the stock ride the bulk of the gains out of its currently depressed value. This strategy will, of course, work best if there is another bid for AstraZeneca later this year by Pfizer

This type of strategy, of alternating between pairs of same sector companies, can work very well during times when market conditions are aggressive. And while it might seem like a strategy that is not for the faint-hearted, if you get it right, you actually decrease your risk overall investing in this way versus just plain old buy-and-hold.

I have to confess that of all our reports, the one I am directing you here is my favourite. For more of these sorts of tips and insights, download the Motley Fool’s guide to navigating the rodeo ride of the new bull market -- it's absolutely free and comes without any obligations whatsoever!

Daniel Mark Harrison has no position in any shares mentioned. 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.