The last year has been hugely disappointing for investors in BP (LSE: BP) (NYSE: BP.US) and GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US), with the share prices of the two companies both falling by 11%. And, while neither of them are the biggest stock in the FTSE 100 (that honour goes to Shell), they remain two of the most appealing stocks based on their valuations, income potential and long-term track records. As such, which is the better buy right now?
For both companies, the future is decidedly uncertain. For example, BP continues to face a number of major challenges that are likely to impact on its share price moving forward. Notably, the lower oil price is apparently here to stay (although predictions regarding its future price level are notoriously unreliable) and this is set to keep investor sentiment in BP in check, as well as cause pressure on its top and bottom line. Furthermore, BP still faces the legacy of compensation payments for the Deepwater Horizon oil spill, as well as uncertainty regarding its near-20% stake in Russian resources operator, Rosneft.
Of course, the future for GlaxoSmithKline is also somewhat difficult to predict. For starters, it is still trying to rebuild its reputation after the bribery allegations, and the full impact on its long term sales numbers is both yet to be felt and is a known unknown. Furthermore, GlaxoSmithKline is coming under increased pressure from investors to deliver improved performance, especially with sector peers such as AstraZeneca set to begin growing their bottom lines from 2017 onwards. In this regard, at least, GlaxoSmithKline has an improving pipeline, with its HIV division, ViiV Health Care, being the jewel in the crown and being capable of pushing GlaxoSmithKlines top line upwards at a brisk pace.
Valuation And Diversity
When it comes to valuing the two companies, there is little to choose between them, with GlaxoSmithKlines price to earnings (P/E) ratio of 17.3 being only marginally lower than BPs P/E ratio of 17.5. Its a similar story regarding their yields (which is also an indicator of their similar level of value), with BP having a yield of 5.7% versus 6.1% for GlaxoSmithKline.
However, GlaxoSmithKline continues to be a more stable company than BP, simply because it has a more diversified product range. For example, a major risk to GlaxoSmithKline is that it is unable to replace key, blockbuster drugs that go off patent and are subject to generic competition. However, even if it loses one, it will still have others and, looking ahead, has the potential to develop new ones and even make acquisitions, given its superb financial firepower and excellent cash flow.
BP, meanwhile, essentially has products that all depend on the price of oil. And, unlike GlaxoSmithKline, it cannot develop new ones over a period of time in order to diversify and reduce the risk to its profitability of a prolonged period of low oil prices. As such, GlaxoSmithKline should trade at a premium to BP, rather than a discount, with its financial performance being relatively uncorrelated to any major external factors including the performance of the wider economy.
Therefore, while BP is a great stock to buy at the moment, GlaxoSmithKline appears to offer a superior business model, greater diversity and lower risk all at a more appealing price and with a higher yield. As a result, GlaxoSmithKline appears to be the better buy of the two right now.
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