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Trade This Defensive High-Yielder for Double-Digit Gains

Melvin Pasternak

In the 13 sessions since the S&P 500 hit an all-time closing high of 1,669.16 on May 21, the market has been bobbing up and down like a cork.

On May 23, it was down more than 23 points, and it shed over 19 points on June 4, only to rebound more than 20 points on June 7.

During periods of this kind of volatility, I prefer to trade defensive groups and set fairly wide stop-losses.

One of my favorites sectors is big pharma -- the major drug companies such as Pfizer (PFE) and Johnson & Johnson (JNJ) -- that have a utility-like quality. These stocks are defensive because they provide products vital for everyday life. Even in a recession you can't cut back on your blood pressure medication.

Most big pharma companies throw off lots of cash, which allows them to pay out above-average dividends. Several of the big players offer a yield of more than 3.5%, nearly double the yield of the S&P 500.

The dividends are attractive to traders for several reasons. First, you get paid to wait. Second, they typically provide a floor under the share price if the period of volatility turns into a full-fledged correction.

One of the most attractive big pharma companies is British giant GlaxoSmithKline (GSK), which trades in the United States as an ADR (American Depository Receipt). I think the stock has attractive technicals and fundamentals.

Technically, the shares are in a strong uptrend with clearly defined support just below the current price.

Fundamentally, earnings are improving through cost-cutting. And patent expirations on the company's blockbuster drugs have less impact on revenues and earnings going forward than in previous years. The company beat consensus estimates by 44%, earning $1.04 per ADR in the fourth quarter of 2012 versus the $0.72 expected. Analyst estimates for 2013 and 2014 project significant improvement. The current dividend yield of more than 4.3% is about double that of the S&P 500, which should help protect the stock in a down market.

Technically, GSK is on a tear.

Since reaching a low near $32 in early 2011, the shares advanced nearly 70% to $54 on May 28, 2013, before pulling back slightly. For most of this period, they were in a clearly defined channel, as marked by the upper line parallel to the trendline. GSK prices broke out of this channel in early April, and came back to test it again during the June 3 trading week. At the same time, they held an accelerated trendline, which began near $43 in March 2013.

The Relative Strength Index (RSI) at 70 is overbought. Moving Average Convergence/Divergence (MACD) is still on a buy signal, but the histogram is beginning to weaken. Therefore, I can see the stock pulling back if the market weakens, presenting a good buying opportunity. There is strong support at $46, a previous resistance level. Above that is a small gap between the $48 and $49 level, which also has the potential to provide support.

Fundamentally, the company is expanding strongly in overseas markets. Emerging market sales comprised about 26% of total sales in 2012 and grew over 10% during the year. The company expects to continue growing strongly in these markets. Although it generally receives less for its products in emerging markets, expenses are also lower, contributing to healthy margins.

Over the next three years, GSK plans to introduce 15 new vaccines and medicines throughout the world, which will contribute to both revenues and profits. A cost-savings program is targeted to cut expenses substantially by 2016.

In 2012, the company earned $3.15 per share. For 2013, the analysts who follow the stock see this number jumping to $3.99, an increase of more than 26%. They project another 7.7% pop to $4.30 in 2014.

With a trailing P/E just under 20, it is well below the 32 average P/E of the generic and specialty pharmaceuticals sector, according to Reuters. From this point of view, the shares represent good value. Also, GSK's price-to-sales (P/S) ratio of 3.12 is less than half of its peers' ratio of 6.57, although the shares are not cheap when measured by price-to-book value.

The combination of a powerful chart, strong dividend yield and attractive valuation leads me to believe the shares should do well whether the market resolves its current period of volatility or corrects.

Risks to consider: Like many big pharma companies, GSK faces pricing pressure in the United States and Europe. That means emerging market sales are key to its success. A worldwide recession could mean lower sales and skimpier profits in these markets.

Recommended Trade Setup:

-- Place a buy stop order for GSK at $48.05
-- Set stop-loss at $44.89, below major support at $46
-- Set initial price target at $57.95 for a potential 21% gain by the end of 2013

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