Neil Woodford is one ofAstraZeneca(LSE: AZN)GlaxoSmithKlines(LSE: GSK) most vocal supporters. The star fund manager has sung the praises of Astra and Glaxos management many times over, and he commended Astras decision to turn down US drugs giantPfizers offer for the company last year.
Indeed, Woodford is so excited about Astra and Glaxos outlook that these two companies make up more than 13.8% of hisCF Woodford Equity Income fund portfolio. Tobacco giants Imperial Tobacco and British American Tobacco make up another 11.5% of the fund, which means that just over 25% of the fund is devoted to four stocks in two sectors.
Is this concentrated portfolio really such a good idea?
Defensive bets
A highly concentrated portfolio can either accelerate or decimate returns. It can take years to recover from just one majorloss, but this doesnt appear to concern Woodford.
One of the reasons why Woodford is prepared to stake his reputation on Astra and Glaxo could be something to do with the two companies defensive nature. As they provide essential pharmaceutical products to customers around the world, Astra and Glaxo arentlikely to see a sudden drop off in business any time soon.
And while they collect a steady income from existing products, the two companies have a raft of new treatments under development, which have the potential to catapult sales higher when they hit the market.
For example, Astra has a total of 222 new drugs under development. The company is planning to conduct 50 treatment trials this year, with several product launches planned between now and 2017. Meanwhile, Glaxo has 258 new products in its pipeline, 40 of which arein advanced clinical trials.
In fact, Glaxos treatment pipeline is the best in the business. The company has more new products under development than any other big pharma group. Glaxos management expects at least half of its drugs currently under development will beon the market by 2020.
Unfortunately, figures show that only around 7% of drugs make it from the initial developmentstage to market. So, by hedging their bets and trying to develop and many treatments as possible in one go, Glaxo and Astra have both increased their chances of success.
Whats more, as the two companies are hedging their bets internally, investors can afford to take extra risk by having a higher allocation to Astra and Glaxo in their portfolio than they usually would. By investing in these two companies, you are betting on the potential success of 480 new treatments theres bound to be a blockbuster in there somewhere.
Undervalued
Along with their sector-leading and highly diversified treatment pipelines, Astra and Glaxo are also cheap compared to their international peers. Peers, including the likes ofNovartis,Pfizer,RocheandSanofi,all trade at an average forward P/E of 22.2. Glaxo and Astra trade at a forward P/Es of 18.4 and 15.6 respectively.
Nevertheless, both Glaxo and Astra’s earnings are set to fall this year and ifyou’re looking for a company with a brighter outlook, the Motley Fool’s top analysts have recently identified a company that they consider to be one of the market’s“top small caps”.
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Rupert Hargreaves owns shares of AstraZeneca and GlaxoSmithKline. The Motley Fool UK has recommended 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.