However much we may like a business, paying too much for the shares will lower our profits at best and lose us money at worst.
Today, I’m looking at whether FTSE 100 pharma giant GlaxoSmithKline (LSE: GSK) and AIM-listed cannabis products specialist GW Pharmaceuticals (LSE: GWP) are simply too expensive.
GlaxoSmithKline
After four years of earnings declines, largely caused by a spate of patent expiries, Glaxo is set to return to growth this year. New product sales are kicking in and half-year results last month showed strong momentum in all three of the group’s divisions of pharmaceuticals, vaccines and consumer healthcare.
At a current share price of 1,680p, the 12-month forecast price-to-sales (P/S) ratio is 3, the price-to-earnings (P/E) ratio is 16.8 and the dividend yield is 4.8%. I don’t believe this valuation is too expensive, and rate Glaxo a buy. If you want to know what too expensive looks like, consider Glaxo’s all-time high of over 2,000p — 15 years ago — when the P/S was 6, the P/E 28 and the dividend yield less than 2%.
GW Pharmaceuticals
GW Pharmaceuticals was founded in 1998 to develop cannabis-based pain relief products. The company listed on AIM in 2001 with initial target markets of multiple sclerosis (MS) and cancer pain. Its only commercial product to date — Sativex for the treatment of MS spasticity — has been selling for over 10 years. Trials continue for a number of other products, with the most advanced being Epidiolex for childhood epilepsy.
The table below shows some key financials for the past 10 years.
| Total revenue (£m) | Sativex product sales revenues (£m) | Net cash flow from operating activities (£m) | Earnings per share (p) | |
| 2015 | 28.5 | 4.2 | (46.5) | (18.1) |
| 2014 | 30.0 | 4.4 | (12.6) | (7.0) |
| 2013 | 27.3 | 2.2 | (7.5) | (3.0) |
| 2012 | 33.1 | 2.5 | 1.8 | 1.9 |
| 2011 | 29.6 | 4.4 | 2.4 | 2.1 |
| 2010 | 30.7 | 2.8 | 4.3 | 3.6 |
| 2009 | 24.1 | 1.7 | 1.2 | 1.2 |
| 2008 | 11.8 | 1.3 | (7.4) | (6.8) |
| 2007 | 5.7 | 1.1 | (1.5) | (8.8) |
| 2006 | 2.0 | 1.3 | (3.3) | (11.2) |
The majority of group revenue has come from research and development fees from partners, with Sativex product sales revenues representing a small proportion of the total. After early growth in both Sativex and total revenue, no real headway has since been made. However, cash-burn has increased rapidly in the last few years as the company pushes to get further products approved and to market.
Q3 results released at noon today show a continuation of this trend. Total revenue for the nine months to 30 June came in at £8.6m, with Sativex product sales revenues at £3.7m. Operating cash-burn accelerated to £57.2m. On the plus side, GW has stacks of cash on the balance sheet, largely thanks to the enthusiasm of US investors (there have been a number of fundraisings since an IPO of American Depositary Shares on the NASDAQ Global Market in 2013).
Too expensive?
So, we have a company whose peak annual revenue to date is £33.1m and whose one commercial product has generated £26m sales revenue over a period of 10 years. How much is GW worth?
The shares are trading at around 600p, valuing the business at over £1.8bn. Taking the peak annual revenue to date of £33.1m gives a P/S of 54 and peak earnings per share of 3.6p gives a P/E of 167. Wow! Remember Glaxo’s P/S and P/E when it was expensive?
GW’s valuation looks crazy to me. It’s priced as if its new childhood epilepsy product Epidiolex is already an approved drug and a nailed-on blockbuster. As such, I can only see this as a stock to avoid on the grounds that it’s simply too pricey.
