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GlaxoSmithKline plc vs Shire PLC: Which Pharma Stock Is The Better Buy?

2015 is forecast to be a challenging year for both GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) and Shire (LSE: SHP) (NASDAQ: SHPG.US). That’s because both pharmaceutical companies are forecast to post declines in their bottom lines in the current year, which is likely to impact negatively upon sentiment in the short term.

However, looking at next year, it is expected to be much brighter for both stocks. In fact, the impact of cost savings is expected to be felt at GlaxoSmithKline, with its earnings forecast to rise by 4% in 2016. Although this is less than the FTSE 100‘s prospective growth rate, it shows that the drug maker is finally moving in the right direction after a highly challenging period. Meanwhile, Shire is expected to increase its net profit by a much more impressive 17% next year, as the company’s sales increase and it continues to turn a great pipeline into higher profitability for investors.

Valuation

While Shire has better growth prospects than GlaxoSmithKline for next year, its share price is less attractive than that of GlaxoSmithKline. For example, Shire trades on a price to earnings (P/E) ratio of 21.8, which is considerably higher than the FTSE 100’s P/E ratio of 16. As such, Shire may have less scope for an upward rating expansion than GlaxoSmithKline, since the latter has a far more appealing P/E ratio of 17.5. And, with GlaxoSmithKline being the larger and better diversified of the two, it could be argued that it should command a higher P/E ratio relative to Shire.

Income Prospects

While GlaxoSmithKline yields a very appealing 5.1%, Shire’s yield is just 0.4% at the present time. And, even though Shire is expected to increase dividends per share by 12.8% next year, it will take a very long period before it becomes as appealing as GlaxoSmithKline when it comes to income prospects. As such, and while GlaxoSmithKline is expected to hold dividends flat in 2016, it remains a much more appealing income stock.

Looking Ahead

While pharma stocks are often viewed as being relatively defensive, GlaxoSmithKline has a beta of 1 and Shire has a beta of 1.3, which means that they are set to offer little in the way of reduced volatility moving forward. And, while both stocks have considerable future potential, the fact that GlaxoSmithKline has a lower rating and much better income prospects means that it remains the better buy of the two companies. Certainly, Shire has greater growth potential but, when it comes to which stock offers the most appealing risk/reward ratio, GlaxoSmithKline remains the more favourable option.

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Peter Stephens owns shares of GlaxoSmithKline. 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.