When I first decided to become a dividend growth investor, GSK is one of the first stocks I looked at. The company met the criteria beginner investors should look for. Namely, GSK has strong Free Cash Flow, a bullet proof balance sheet, good returns on capital (12%), strong returns on equity (15%) is an easy to understand business,has stable and predictable growth, has economic moats in its consumer business and it pays a hefty dividend. What also swung me to looking at GSK was the number of income fund managers holding this stock in their portfolio thus showing that the company is highly regarded in the wealth management world.
The one thing that stopped me from pulling the trigger and pressing the buy button was the valuation. Even though GSK has been cheap for the past few years by traditional valuation formulas such as the P/E ratio, I for one found valuing the stock to be a bit more challenging. For one, I didn’t know how to value the company’s pharmaceutical unit as a number of patents were about to expire. This made forecasting cash-flows difficult and as I could not put an intrinsic value on the company’s shares, I simply walked away from the company.
Since I first looked at GSK, the company has gone on a bit of a transformative run. For one, it swapped its more volatile oncology unit in order to acquire the more stable and predictable consumer and vaccines business. Another thing the company has done is to alleviate fears of the patent cliff by product differentiation and discovery of new drugs.
With all these changes that have occurred to GSK over the past couple of years, it has become much more easier to value the company. This is the reason why I have started to buy shares.
Using a simple discounted cash flow analysis, the intrinsic value of GSK which I calculated is £17.54. For this I have assumed free-cash-flow in 5 years is £7, 632m, terminal growth rate is 1.5% and discount rate is 9.5%.
GSK currently trades around £16.40 implying a discount to intrinsic value of close to 7%. This is by no means cheap and I usually buy stocks with higher margins of safety.
What is Pound Cost Averaging
Pound Cost averaging is a way to buy shares in small increments as opposed to making one big lump-sum purchase.
You basically place an order for a specified amount of money to buy the same share or a fund each month in the same way you’d set up a direct debit to pay your utility bill or a gym membership, for example. Many stockbrokers call it a ‘regular investment service’.
In the UK, transaction fees for the regular investment service is usually much lower than
normal trading costs, often as little as £1.50 a time versus £10 typical dealing fee. ( With Free trade coming later this year, transaction costs may be a thing of the past).
Pound cost averaging is designed to iron out the ups and downs in the price of a share over time. Your money buys you more shares when the price is low and fewer when the price is high. That can be better than mistiming the market and only making one transaction and buying when the price was high, for example
Pound Cost Averaging – An Illustration Using GSK
Regular readers will know that I have been pound cost averaging (or dollar cost averaging) my way into GSK as of late. I have been using this method because GSK is not currently cheap enough to warrant a full on purchase. Having said this, the company still offers good value going forward and any small catalyst such as a new drug discovery or a decisions to break up the company will send the share price rocketing upwards. These things can happen at any time and I know that if I hadn’t been buying this stock and the price shoots upwards, I will be kicking myself. Now I am not saying that I am investing in the ‘hope’ of a new discovery of a break-up of the company. Even if these things don’t happen I will still be happy to own GSK shares at current prices.
Another reason why GSK is a great stock to dollar cost average in to is because the company has been trading in a regular band between £13 and £17 a share over these past 5 years. By dollar cost averaging, instead of timing my purchase, I buy shares at regular monthly intervals for a set amount. Thus if the price is high, I buy less shares and if the price is low, I buy more shares.
I started buying GSK shares in December 2016. Here is a breakdown of the shares I have bought in the company so far.
- December – Bought 11 shares at £15.00 each. Total cost £165
- February – Bought 10 shares at £15.98 each. Total cost £159.8
- March – Bought 9 shares at £16.70 each. Total cost £150.3
- April – Bought 10 Shares at £16.40. Total cost £164
As you can see from the above, when the shares were the cheapest in December, I bought the most and when shares were the most expensive in March, I bought the least. This is the great aspect about pound cost averaging. You get to spread your cost/purchases over a number of month and in doing so you get the chance to buy shares for cheaper if the price falls or if the price rises you can buy less shares and enjoy your capital gain.
Over the coming months, I will continue to pound cost average my way into GSK shares provided the shares remain below intrinsic value. If the stock price was to drop substantially from here, I would go big and make an outright purchase.
All in all, I currently have 40 shares in GSK which pay me an annual dividend of £32. I expect this dividend to keep rising as I buy more shares in this healthcare giant.