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GlaxoSmithKline’s logo appears on its offices in west London. The company will divest some assets in exchange for others from Novartis.TOBY MELVILLE/Reuters

Two potential multi-billion dollar deals highlight optimism over the global pharmaceutical sector.

Drug stocks are already outperforming: Over the past 12 months, the S&P 500 Pharmaceutical and Life Sciences Index's total return of 29 per cent outpaced the S&P 500 by seven percentage points. Much of the outperformance occurred this year; the Pharma index climbed 8.7 per cent relative to the S&P 500's 1.8 per cent.

Traditional pharmaceutical companies don't have the high-flying upside of biotechnology stocks, but they are also less volatile. In March, when the S&P 500 Biotechnology sub index plummeted 11 per cent, the pharmaceutical index fell back by a far more palatable 2.7 per cent.

Investors should view pharmaceutical companies as virtual utilities, grinding out dividends and profits as a steadily aging developed world population increases demand for their products. Importantly, pharma stocks are counter-cyclical – they're not dependent on overall economic growth.

Yet, although investors in pharma stocks can worry less about the economy, that doesn't mean the sector is without risk. Government regulation and patent expiries are only two of the industry-specific factors that can boost or squash profitability.

More recently, the risk that a traditional pharma company blows up its balance sheet with a huge acquisition in the biotech sector has also become a huge issue. Investors in Switzerland-based Roche AG, for instance, cried foul in July 2008 when the company agreed to pay $44-billion (U.S.) for biotech giant Genentech Inc.

These risk factors make diversification through pharmaceutical ETFs an attractive option. The problem is, the most popular sector ETFs only include the U.S. pharmaceutical companies and omit some of the highest quality, biggest yielding drug developers in Europe. This includes Roche Holding AG, Novartis AG and Glaxosmithkline PLC.

Our table sorts the world's largest 26 pharmaceutical companies by forward price-to-earnings ratio. Forward, rather than trailing P/E, encompasses the potential effects of regulations and patent expiries.

Generic drug manufacturer Teva Pharmaceutical Ltd. is the most attractive by this measure, but the company has struggled with profit growth and the consensus price target is well below current levels.

Glaxosmithkline, Pfizer Inc. and Shire plc look the most promising. Glaxosmithkline has the highest dividend yield in the sector at 5.3 per cent, high profitability in terms of return on equity and a strong recent history of profit growth.

Pfizer also pays a nice dividend and has grown earnings at a rapid clip over the past three years.

Ireland-based Shire PLC is more of a growth story than a dividend play. The company specializes in drugs for attention deficit disorders and its big seller is Adderall, the modern university student's best friend. Shire's stock is not the cheapest in the sector, but profits have almost doubled in the past twelve months, indicating the company has found a profitable niche.

(Hey app users, can't see the table? Click here: http://bit.ly/1mvtDnw)

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