GlaxoSmithKline: The Right Prescription

After several years in the sick ward, pharmaceutical stocks are perking up. The Amex Pharmaceuticals index of 15 big drug stocks has advanced 10% this year. As economic growth slows, several of the stocks in this classic defensive sector are looking attractive.

David Herro, manager of Oakmark International, is a big fan of GlaxoSmithKline (symbol GSK), a former growth stock that he says now sells at value-stock prices. Glaxo closed on October 6 at $54.31 a share, just 15.5 times estimated 2006 earnings, and yields 3%. What the company hasn't lost is an almost obscenely high level of profitability -- net profit margins of 22% and an off-the-charts return on equity of 72%.

What distinguishes Glaxo is its balanced, diversified portfolio of medications on the market and a robust pipeline of drugs in development. Half of sales are in the U.S. and half are foreign. The company, based in England, is a leader in vaccines and treatments for asthma (brands include Seretide and Advair), diabetes (Avandia) and HIV/Aids. In the works are vaccines for avian flu and cervical cancer and more medications to fight diabetes, a disease on the rise worldwide.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

Even if the economy is feeble next year, Glaxo is likely to still be a picture of good health. The company annually generates more than $9 billion of free cash flow (earnings plus non-cash charges, minus the capital expenditures needed to maintain the business), equivalent to 23% of revenues. Shareholders should see a chunk of that cash come back in the form of fatter dividends and share buybacks.