With market volatility being relatively high at the present time, buying pharmaceutical companies could prove to be a wise move. A key reason for this is that their business models are a lot less dependent upon the performance of the wider economy that for most stocks, since the development of new drugs and their sales tends to be somewhat detached from the macroeconomic outlook for the wider economy. As such, shares in GlaxoSmithKline (LSE: GSK) and Dechra (LSE: DPH) have held up better than the wider index during the last month, with them being down by 5% each versus almost 8% for the FTSE 100.
However, there is much more to both stocks above and beyond their relatively low correlation with the performance of the wider economy. Certainly, the pharmaceutical industry is a boom/bust space, with the loss of patents on blockbuster drugs having a negative impact on sales and profitability in the short run. There is, though, excellent growth potential on offer and, in this regard, both GlaxoSmithKline and Dechra are set to perform exceptionally well.
For example, GlaxoSmithKline is forecast to increase its earnings by 12% next year as it continues to make encouraging progress regarding cost savings and other efficiencies. This puts the stock on a price to earnings growth (PEG) ratio of just 1.3, which indicates that its share price could be set to move upwards at a brisk pace. Similarly, Dechra is expected to increase its bottom line by 11% next year and, although it trades on a PEG ratio of 2, its excellent track record of growth (earnings have increased at an annualised rate of 11% during the last four years) indicates that it is a relatively reliable performer that is worthy of a premium.
Furthermore, Dechra also has a very low beta of 0.4. This means that for every 1% move in the level of the wider index, Dechra’s share price is expected to change by just 0.4%. And, with the short to medium term prospects for the FTSE 100 being highly uncertain, this could be a major positive for investors. Meanwhile, GlaxoSmithKline offers a yield of over 6% at the present time and, while dividends are not due to rise over the next couple of years, such income prospects are likely to provide considerable support for the company’s share price so that even if the wider index falls, GlaxoSmithKline’s share price should hold up well.
Clearly, the share price performance of the two companies in recent years has differed significantly. While Dechra has soared by 124%, GlaxoSmithKline is up by just 8%. However, looking ahead they both appear to offer strong growth prospects at a reasonable price and, while Dechra’s yield of 1.8% is somewhat disappointing, it has a payout ratio of just 42% and this indicates that its dividends could rise substantially over the medium to long term. Equally, GlaxoSmithKline’s fall in profitability of 14% in the last three years may be disappointing but, with a bright medium-term future, it appears to be a perfect moment to buy a slice of the company alongside Dechra.
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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.