For investors in Smith & Nephew (LSE: SN) and Hikma (LSE: HIK), the last five years have been superb. That’s because the two health care companies have posted share price gains of 107% and 224% respectively, which is well ahead of the FTSE 100’s rise of 24% during the same time period.
Strong growth prospects
Clearly, investor sentiment in the two stocks has been very strong and, looking at their current ratings, this is very evident. Both companies trade on relatively high price to earnings (P/E) ratios of 22.5 (Smith & Nephew) and 25.7 (Hikma), which may lead many investors to discount them as potential investments due to them being viewed as overpriced.
However, both stocks have strong future growth prospects to back up their generous valuations. For example, Smith & Nephew is expected to post earnings growth of 14% next year and, when this rate of growth is combined with its P/E ratio, it equates to a price to earnings growth (PEG) ratio of 1.4. This indicates that there is scope for the company’s share price to move higher. Similarly, Hikma is forecast to grow its earnings by 12% next year and, with it trading on a PEG ratio of 1.8, seems to offer further capital gain potential, too.
Turning the tables
Meanwhile, the last five years have been challenging for investors in GlaxoSmithKline (LSE: GSK). It has been embroiled in controversy regarding alleged bribery and has failed to rejuvenate its product offering, with the consequence being that sales and profitability have come under severe pressure. As a result, GlaxoSmithKline’s share price has risen by just 15% since August 2010, which is a small fraction of the performance of Smith & Nephew and Hikma during the same period.
Looking ahead, though, GlaxoSmithKline has huge potential to turn the tables on its two health care peers. Vast cost savings are successfully being implemented so as to make the business leaner and more efficient, while GlaxoSmithKline’s pipeline is still very strong and capable of stimulating its top and bottom lines over the medium to long term. In fact, GlaxoSmithKline’s earnings are due to rise by 12% next year, thereby putting it on the same PEG ratio as Smith & Nephew of 1.4.
The balanced choice
While the pharmaceutical industry is characterised by its boom and bust nature, the health care and equipment industry (to which Smith & Nephew belongs) is far more stable and predictable. As a result, the chances are that Smith & Nephew will prove to be the steadier performer over the medium to long term.
However, with GlaxoSmithKline able to almost match its short term growth prospects and also yielding around 5.7% (versus just 1.7%) for Smith & Nephew, it seems to be the more balanced investment. So, while all three stocks are poised to deliver on bright futures, GlaxoSmithKline remains the preferred option at the present time.
