GlaxoSmithKline (LSE: GSK) and Quindell (LSE: QPP) are both heavily traded by private investors. But that’s where the similarity ends.
At today’s prices, I’d be happy to double my holding in Glaxo if I had the cash. Yet I’d have no hesitation in selling shares in Quindell, especially after Wednesday’s surprise 8% gain.
Here’s why.
1. Is my capital safe?
One of the best ways to make money in shares is to avoid big losses. As Warren Buffett famously said, “Rule number one is never lose money. Rule number 2 is never forget rule number one.”
A large part of Quindell’s 91p share price is based on the expectation that the firm will make good on its promise to return 100p per share to shareholders. This money came from the sale of the firm’s legal services division to Australian firm Slater & Gordon.
Yet this payout isn’t safe. Quindell is under investigation by the Serious Fraud Office. This process could generate massive legal costs and potentially some fines. If I was a director at Quindell, I’d be inclined to hang on to the cash until I was sure it was surplus to requirements.
If the 100p payout is reduced or cancelled, Quindell shares will plummet. Shareholders could face a permanent loss of capital.
This is not a serious risk at Glaxo. The firm’s valuation may vary over the years, but it is backed by real assets which generate cash flow and profits and have a marketable value.
Glaxo’s conduct may not always be perfect, but the firm is able to weather such storms thanks to its scale and diversity.
2. The message from the market
Glaxo shares currently trade on a forecast P/E of 18.5 and have a price-to-sales ratio of 3. This may not seem especially cheap, given the firm’s current weak earnings. However, this strong valuation is a measure of the market’s confidence in the long-term earning power of Glaxo’s assets.
Many institutional investors, such as Neil Woodford, believe that Glaxo’s current valuation does not reflect the longer-term potential of its product portfolio.
Thinking along the same lines, what does Quindell’s current valuation suggest about the market’s view of the firm?
Quindell currently has a market capitalisation of just £405m. That’s less than the firm’s £535m cash balance and less than the £450m which would be returned to shareholders if the £1 per share payout goes ahead.
The implication is clear, in my view. The market doesn’t see much value in Quindell’s remaining businesses and is pricing in a reduction to the planned 100p per share payout.
3. Profit, cash flow and dividends
The final reason I’d buy Glaxo and sell Quindell is that the pharmaceutical firm is the only one of these companies that operates like a sustainable business.
Glaxo’s operating margin has averaged 22.9% over the last five years. In this time it’s generated £19.5bn of after-tax profits and paid 367p per share in dividends.
In contrast, over the same period Quindell has reported post-tax losses totalling £411m and paid 1.5p per share in dividends. It’s also facing a Serious Fraud Office investigation.
Which company do you think is more likely to be a successful investment?