Why I Bought GlaxoSmithKline plc

gskA quote from Albert Einstein, perhaps apocryphal, goes:

“Everything should be made as simple as possible, but not simpler.”

Investing is akin to predicting the future, but while I can’t tell you exactly how the world will look in 10 years’ time, I can tell you what will be the same.

People are still going to get sick and we’ll need medicine to make us healthy again. That’s the crux of investing in pharmaceutical companies. We’re investing in a future that’s simple to understand, and more importantly, certain.

But let’s not oversimplify here. For one thing, we need to sort our New Molecular Entities (NMEs) from our New Musical Express (one has slightly less of a drugs bent than the other). Then we need to decide which stock to load up on.

GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) is the UK’s largest pharmaceutical company with annual sales of £27bn. Glaxo’s shares have fallen in 2014 on corruption allegations (later proven) in China. This will ultimately blow over. What I’m more concerned with is the drugs pipeline.

Historically, the market has done a poor job of recognising the future value created by new medical treatments. Glaxo’s valuation looks attractive when you factor in the 40 NMEs in late stage clinical development, which will lead to new products and sales. Even assuming only modest growth the shares, with a 5.6% dividend yield, look attractively priced at around £14.

GSK spent £3.4bn of revenue on R&D last year. It’s an investment in innovation. This promise and thrill is what investing is all about, but the market mistakenly treats R&D as a cost, hence the pricing anomaly. Sooner or later, new product launches and rising sales should lift the shares.

The UN forecasts that the world’s population will rise from 7.2 billion to 9.6 billion by 2050. Glaxo has identified emerging markets as a significant long-term opportunity. Rising incomes in countries such as China, India and Brazil will lead to increased demand for healthcare, and Glaxo has invested heavily to make sure it gets its piece of the pie.

An added bonus is that shares in pharmaceutical companies aren’t as sensitive to the economic headwinds. The dividend has increased at a compounded 6% over the last five years — an impressive track record. Although the company is being reshaped after warning on 2014 profits, the top class drugs pipeline and a bulked up vaccines business should eventually bear fruit for shareholders.

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Mark Stones owns shares of GlaxoSmithKline. The Motley Fool UK has recommended shares of 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.