Glaxosmithkline Looks Worthy Of Investment

Jun. 8.07 | About: GlaxoSmithKline (GSK)

A major tenet of efficient markets is the idea that most of what's known about a company, its prospects and risks, is already baked into the stock price. Any performance deviation comes from random, unpredictable events. So when investors talk about a company's products, management, competitors, etc. they are addressing topics that are already known, and presumably factored into the stock price. The key is some unique insight, that isn't incorporated into the stock, that you're confident will eventually be 'discovered' and acted upon, driving the stock price in the direction you want.

The hardest thing when assessing stock valuations is putting a price or magnitude on this perceived insight. Fellow Investment Director Eliot Penn highlighted Glaxo SmithKline (NYSE:GSK) the other day, basically arguing that it looked cheap and likely to rebound. The "cheapness" of GSK comes from recent poor fundamentals, problems with drugs, etc., but the real question is if it's fairly priced now, given those issues, or have investors over reacted and it is truly "under-valued", and thus worthy of investment. A tough call, and hard to determine in isolation. That's where quantitative research helps provide guidance.

My models emphasize relative valuation, low P/E, P/Cash Flow, etc. and in this dimension, GSK looks attractive. Yet on other important measures, GSK looks like dead money. Recent earnings downgrades and negative earnings surprises, have driven the stock down and generally given investors pause. Yet, historically, stocks with this combination of attractive valuation, sound balance sheet, growth prospects, and recently beaten down price, tend to, on average, outperform over the next 6-12 months. Given the GSK's large cap strength and international diversification, it might also be positioned to weather market sell offs better than most. Investors often over react to recent events, pushing stocks too high or low relative to their long term merits. This is what quantitative research helps discover, when stocks are mis-valued, and what characteristics distinguish this.

Research over the last 30 years indicate that stocks with the quantifiable characteristics of GSK have outperformed roughly 57% of the time - not a certainty by any means, but certainly better than average. My research concurs with Eliott - GSK looks worthy of investment.