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Is the GSK share price heading for 2,000p again?

It’s a long time since GlaxoSmithKline (LSE: GSK) shares were valued above 2,000p. Not since the summer of 2001, in fact. With the shares trading today at a little over 1,520p, that’s a drop of 24%.

But don’t we at the Motley Fool expect shares to go up? Surely 17 years is sufficiently long term, isn’t it? Well, what this really demonstrates is the need for diversification, which is another core Foolish principal.

Suppose you’d also bought some Unilever shares at the same time. They’d have trebled in value over the same period. British American Tobacco has six-bagged, and even Prudential has put on 136%. And, of course, you’d have earned dividends on top.

OK hindsight is a great thing, but a mix from different sectors and different indexes would, I reckon, almost certainly have resulted in a healthy total yield.

Price crunch

But back to GlaxoSmithKline, whose share price fall was triggered by the loss of some key drug patents and the subsequent competition from generic manufacturers.

With the long lead time from the start of drug research to eventually getting new products out on the market, getting Glaxo’s development pipeline back up to speed and hopefully delivering new blockbusters was never going to be a quick job. But the patience does seem to be paying off, and the company returned to decent earnings growth in 2016. It’s still too early to tell how sustainable that will be, as there’s no growth on the cards for this year, and just a modest 4% for 2019.

Investor confidence does appear to be returning slowly, with Glaxo shares up 45% since their low point in May 2009. Admittedly, the FTSE 100 gained nearly 60% over the same period, so it’s not a cracking performance — but it could just be the start.

Target

What about that 2,000p target? Analysts are predicting earnings per share of 116p in 2019, and that would put the shares on a forward P/E of 13. If we guess at 14 for Glaxo’s long-term fair P/E valuation (chosen simply because that’s about the FTSE 100’s long-term average), we might conclude that Glaxo shares would be fair value at around the 1,630p level — approximately 7% up on the current price.

But that’s ignoring dividends, and Glaxo’s are big. The company has been maintaining yields of between 5% and 6% over the past five years, and analysts are predicting 5.3% for this year and next. That’s significantly better than the Footsie’s current average of around 4.3% (and that in turn is ahead of its longer-term range of around 3.5% to 4%).

For most investors, a bigger dividend is worth paying extra for and justifies a higher P/E rating, and I’d be happing shelling out for big-dividend shares rated at P/E levels of 17-18 or so, maybe even higher. Being conservative and assuming 17, that would already suggest a share price target of close to 1,990p on 2019 forecasts, even without further earnings growth.

Even if the P/E never climbed above 14, it would only take a rise in earnings from that 2019 forecast onwards of 23% to reach a 2,000p share price. Five years of 5% EPS growth per year would exceed that, and I can easily imagine Glaxo’s earnings growing faster than that.

Yes, once we see sustainable earnings growth, I think confidence will improve — and I see 2,000p as an achievable medium-term share price target.

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline and Unilever. The Motley Fool UK has recommended Prudential. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.