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GSK’s share price: how would Warren Buffett value the stock?

July saw GSK's [GSK] share price hit its highest point in over two years as Q2 results delivered a shot of adrenaline. So far this year, the stock has seen a 9.4% gain, beating the FTSE 100’s 4.4% rise. 

Still this looks sluggish next to rival AstraZenaca's [AZN] 21.4% gains. And for traders looking at things from a pure share price growth perspective, AstraZenaca might appear the more obvious option. But if you adopt the methods used by Warren Buffett and look past the usual valuation metrics, GSK is a stock that could deliver in the long-term.

 

Looking past the usual numbers

Last week Stockopedia author Jack Brumbley wrote that the best stocks aren't necessarily the cheapest. Brambley points to Warren Buffett who looks past the standard valuation metrics like price-to-book. Instead, Buffett focuses on how a company is using shareholders’ equity to generate profits. This allows him to choose high quality stocks that deliver long-term returns.

On the face of it GSK might look more expensive than other FTSE 100 stocks. Yet GSK’s return on equity - one of Buffett's favoured metrics -  has seen a 161% gain over 12 months. This shows an incredibly efficient use of shareholder money. Rival AstraZenaca, on the other hand, has a ROE of just 14% despite the soaring share price.

 

Market cap £83.04bn
PE ratio (TTM) 18.75
EPS (TTM) 88.80
Profit margin 13.94%

GSK share price vitals, Yahoo finance, 19 August 2019

 

 

Capable management goes a long way

Another part of Buffett's strategy is to look for companies with capable management. Part of this is looking at what a new CEO does once they take charge of a company:

“Look at what they have accomplished, considering what the hand was that they were dealt when they took over compared to what is going on in the industry,” Buffett is on record as saying.

On this, relatively new CEO Emma Walmsley has been proactive in turning a once lacklustre operation around. Walmsley has done this by moving GSK towards high profit prescription medicines and away from consumer healthcare. This has seen GSK make major oncology deals, including picking up Tesaro and its cancer treatment pipeline for $5.1 billion. Walmsley has also overseen the merger of the company's healthcare operations with Pfizer.

International expansion has played its part. In China, authorities have approved the drugmaker’s shingles treatment Shingrix for adults aged 50 and over. This follows the treatment’s blockbuster US launch. According to IQVIA data, China is both the world's second biggest pharmaceutical market and the fastest growing. By 2022 the Chinese market could be worth between $145 billion to $175 billion.

“Look at what they have accomplished, considering what the hand was that they were dealt when they took over compared to what is going on in the industry” - Warren Buffett

Such initiatives are already starting to pay off. Last month cancer drug Zejula, picked up from the Tesaro deal, went through trials. According to Jefferies analyst Peter Welford the results show the drug could become the best-in-class option for a high number of ovarian cancer patients.

Buffett also looks for companies that reward the shareholders or, as he calls them, the ‘bosses’. On this point, Walmsley has been good to shareholders. For income seeking investors, the stock saw a 19p dividend for Q2, with expectations for a payout of 80p a share for the year. The stock’s payout ratio is a huge 90.02%.

 

Is GSK's share price a buy?

The final part of Buffett's approach is to gauge whether a stock is sensibly priced. GSK's share price has an 18.52 price-to-earnings multiple over the past 12 months. This is much lower than AstraZenaca's 51.18, indicating shareholders are getting a more reasonably valued stock. 

Looking at earnings, things seem to be going in the right direction. In the last quarter, GSK saw group sales climb 7% to 7.8 billion. Highlights included a 26% year-on-year jump in vaccine sales. This was enough to see GSK lift its earnings guidance for 2019.

Analysts, however, seem uncertain on the stock with 15 out of 26 rating the stock a ‘hold’ on Yahoo Finance! The consensus price target is 1,644p, which would represent a 0.8% downside on Friday’s share price. Investors will need to decide if analysts have got it right or if GSK’s efficient use of shareholder money and strong management means there’s more growth to come.

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