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Is GlaxoSmithKline plc Capable Of 20%+ Returns?

The health care sector continues to hold huge appeal for investors. Not only does it offer relatively defensive prospects when compared to the rest of the index, it also has the potential to deliver stunning earnings growth rates in the long term.

For investors in GlaxoSmithKline (LSE: GSK), though, neither of these qualities have been in evidence during recent years. Its shares have only marginally outperformed the FTSE 100 over the last five years, up by 14% versus 12% for the wider index. Furthermore, GlaxoSmithKline’s bottom line has fallen by a third in the last four years as it has struggled to overcome sales declines on a number of key drugs and treatments.

Reaping the benefits

However, the future is likely to be a lot different to the past. That’s because GlaxoSmithKline has endured a hugely challenging period which has included allegations of bribery that  have not only hurt its sales performance but have also caused investor sentiment to wane. Looking forward, though, earnings growth of 11% is forecast for next year, as the company is due to begin reaping the benefits from a major cost saving programme which is forecast to deliver £1bn in savings over a three year period.

So, even if GlaxoSmithKline retains its current rating, its shares should, in theory, rise by 11% over the short to medium term as a result of its improving profitability. However, there is also scope for an upward re-rating, too. That’s because GlaxoSmithKline trades on a price to earnings (P/E) ratio of 18.3 which, while higher than the wider index, does not appear to be overly generous when the company’s pipeline is taken into account. It has the potential to transform GlaxoSmithKline’s bottom line, with the company’s ViiV Health Care division in particular having the scope to deliver multiple blockbuster drugs over the coming years.

Very capable

In terms of a potential catalyst to push GlaxoSmithKline’s rating higher, factors such as a lack of negative news flow about things such as bribery allegations could make a real difference to investor sentiment. Similarly, an uncertain outlook for the wider index may cause investors to seek out companies which offer less positively correlated earnings to the wider economy than for most of the FTSE 100’s constituents. Meanwhile, delivery of the company’s turnaround strategy may also cause investors to become more optimistic regarding its future prospects. As such, GlaxoSmithKline’s P/E ratio could expand in 2016 and beyond and add to its previously mentioned 11% share price growth potential.

In addition, GlaxoSmithKline’s yield of 6% continues to have huge appeal. Certainly, the company is not due to increase its dividend per share over the next couple of years, but with shareholder payouts already being high relative to profit, it seems to be a prudent move to hold them at around their current level over the medium term. And, when a dividend yield of 6%+ is added to the aforementioned scope for a rating upgrade as well as rising profitability, GlaxoSmithKline seems to be very capable of delivering 20%+ total returns over the medium term.

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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.