In unsettled times in the market or the economy, investors often look to the big drug stocks for some safety. People get sick regardless of the economic cycle, so companies that cater to healing them often outperform during downturns, and their stocks are considered "defensive." Healthy and dependable dividends can also contribute to stabilizing portfolio returns in good times and bad.

Two successful blue-chip stocks in the healthcare industry are British GlaxoSmithKline plc (GSK -0.46%) and Eli Lilly (LLY -0.61%). Investors like both stocks for their dividends and consistent performance, but the companies are really quite different, with GlaxoSmithKline diversified into vaccines and consumer products, and Eli Lilly focused on pharmaceuticals. Which stock represents the best opportunity for investors today? The answer depends partly on investment priorities.

Pills in the shape of a dollar sign.

Image source: Getty Images.

Stock performance and valuation

From the point of view of stock price performance, there is no comparison. Eli Lilly is having one of its best years in decades after going sideways for the previous three. Its stock is up 37% year to date, the most of any big drug stock, and 52% since the low point in March. In contrast, Glaxo stock is up 16.9% this year, but it has generally trended downward for the last five years.

The run-up in Lilly's stock price this year reflects the fact that the market has rewarded the stock with a higher valuation due to the strong performance of its business, so it's not surprising that Glaxo stock looks like the better bargain on the surface. Both companies have had some large, one-time charges due to acquisitions, restructuring, and the change in the U.S. tax law. To get a feel for the relative valuation of the two stocks, it makes sense to look at the ratio of the stock price to the earnings per share that analysts are expecting for 2018, adjusted to subtract the one-time charges.

Analysts are expecting Lilly to earn adjusted EPS of $5.47 in 2018, which means the stock is selling for about 20 times earnings, putting it near the pricey end of large drug companies. Glaxo, on the other hand, is selling for about 13 times the analyst consensus of $2.95 for the year, which makes it a bit cheaper than most of its peers.


Looking simply at dividend yield, Glaxo beats Lilly by a mile. Lilly pays $2.25 in dividends per year, which translates into a yield of 2%. At today's exchange rate between the dollar and the British pound, Glaxo's annual dividend works out to be  $2.11, for a yield of 5.4%. Some dividend investors will prefer the higher yield, but the picture for dividend growth is another matter.

Glaxo's dividend isn't likely to grow any time in the near future, and some investors are worried that it could be cut. For years, the company has been paying out more than it's making in free cash flow, but that situation isn't going to continue. Management has made clear that after 2018, the dividend rate will be set according to the free cash flow the company is able to generate, and its intention is not to raise the dividend until free cash flow is 125% to 150% of the payout. At this point, it's not even close to that; free cash flow in 2017 covered only 88% of the dividend payout. 

Eli Lilly, on the other hand, is in a stronger financial position. In the last year, the company raised its dividend 8.2% and reduced its share count through buybacks by 2.4%. With 2017 free cash flow that was over twice what it paid out in dividends, Lilly has plenty of leeway to continue to increase its dividend while still investing for growth.

Growth prospects and risks

GlaxoSmithKline is at a point today that is reminiscent of where Eli Lilly was several years ago. The loss of exclusivity of its blockbuster respiratory drug Advair is creating a headwind that is holding back the company's results and creating uncertainty for investors. The price of the drug has been dropping like a rock, causing sales to fall 24% in the first half of the year. Once a generic version actually comes on the market in the U.S., the impact will be even worse. Glaxo even gave two estimates for full-year EPS growth, depending on whether a competitor for Advair appears. If no generic competition for Advair is introduced in the U.S. in 2018, Glaxo expects adjusted EPS growth of 7% to 10% in constant currency. If it does appear, growth of EPS in constant currency could be as low as 4% to 7%. That competition is more a matter of "when" than "if," though.

On the other hand, Glaxo is having tremendous success with its new shingles vaccine, Shingrix, which is expected to have sales of between $792 million and $858 million this year. The company's HIV drugs have also been very successful, with sales that grew 11% in constant currency in the latest quarter. 

Lilly went through a period of patent expirations between 2011 and 2014 but is now seeing accelerating growth as newly introduced drugs are gathering steam. In the latest quarter, newly introduced drugs had worldwide volume growth of 12.4%, easily compensating for losses of 6.2% in volume of older drugs.. There is also less risk in the company's portfolio, since it's not as reliant on a single best-seller, like many of its peers. Its biggest seller in the most recent quarter was Trulicity at 12% of total revenue, and sales of that drug grew 62% from the period a year earlier. Lilly's latest guidance is for EPS growth of 27% on top-line growth of 6%.

Longer term, Lilly has been investing in its drug pipeline, with 21 phase 3 and 11 phase 2 trials under way, featuring three promising, non-opioid pain drugs in late stages of development. The company's balance sheet is strong, thanks in part to repatriated overseas profits, so it's making acquisitions to build that pipeline even further. Also, it recently spun off its animal health business, which will have the effect of boosting Lilly's growth rate.

Glaxo has potential blockbuster drugs in its pipeline as well, but it has also been investing in vaccines and in consumer products, which are categories with slower growth but less risk from trial failures and loss of exclusivity.

High yield today, or better growth and stronger financials?

GlaxoSmithKline offers a dividend yield that is higher than any of its peers, and it has a diversified healthcare business that should tend to be fairly stable, but with modest growth, over the long term. I don't think Glaxo's management will go so far as to cut the dividend, but any growth in the payout is likely to be several years away. Low growth, nervousness about the dividend, and the specter of Advair generic competition all add up to a stock price that isn't likely to go anywhere soon unless something changes, which explains the low valuation. But some investors who are looking for high current income may still want to consider the stock.

On the other hand, Eli Lilly has a low yield, relatively expensive shares, and excellent growth prospects. I don't think either stock is particularly compelling at the moment, but I wouldn't hesitate to choose Lilly over Glaxo for long-term investors who are not too concerned with current dividend income. Over time, the payoff from its drug development program should produce enough share appreciation to more than compensate for the lower yield.