Will GlaxoSmithKline plc Slide To £10… Or Soar To £20?

One of the advantages of owning shares in defensive companies is that when the market falls there’s a good chance they’ll outperform their index peers. That’s exactly what has happened in 2016 with health care company GlaxoSmithKline (LSE: GSK), with its shares outperforming the FTSE 100 by around 7% since the turn of the year.

Clearly, GlaxoSmithKline has a return less highly correlated with the macroeconomic outlook than is the case for the wider index. This means that its earnings are less affected by an economic downturn than is the case for most of its index peers. As such, its shares tend to become increasingly popular during periods of uncertainty. With volatility and risk set to remain relatively high during the medium term, GlaxoSmithKline could become an even more popular stock moving forward.

Income play

In addition, GlaxoSmithKline continues to have high income appeal. Although the company has stated that it expects zero dividend growth over the medium term as it continues to restructure, its yield of 5.7% is still among the highest in the FTSE 100 and unlike a number of other high yields, is very likely to be paid owing to GlaxoSmithKline’s robust income stream. With interest rates due to remain low, GlaxoSmithKline could become a must-have stock for investors seeking to balance lacklustre FTSE 100 capital gains with a high and reliable income.

Of course, GlaxoSmithKline isn’t just a defensive income stock. It also has excellent earnings growth potential, with its decision to slash costs over the medium term anticipated to deliver up to £1bn in savings. This should help to improve margins and with GlaxoSmithKline also having a well-diversified and exciting pipeline of potential new treatments, it seem to be in a strong position to grow its top and bottom lines. Evidence of the progress being made in respect of the latter can be seen in forecasts for the current year, with the market expecting a rise in net profit of 11%.

With GlaxoSmithKline trading on a price-to-earnings (P/E) ratio of 16.6, it appears to offer good value for money when its earnings growth rate is taken into account. In fact, when earnings growth is combined with GlaxoSmithKline’s rating it equates to a price-to-earnings growth (PEG) ratio of just 1.5, which indicates that growth is on offer at a reasonable price.

Growth needed

In order to trade at £20, GlaxoSmithKline is likely to need to grow its bottom line yet further, since it would otherwise require a rating of 23.7 to trade there based on 2016 forecast earnings. However, with a strong pipeline of new drugs (particularly from its ViiV subsidiary), an appealing valuation, high yield and defensive prospects, index-beating capital gains are very much on the cards. And with the potential to grow profit yet further, a share price of £20 is realistic in the long run too.

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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.