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The pharma legend is a good bet for income investors.
Right now, Merck (NYSE: MRK), this nation’s second biggest pharmaceutical maker, is a curious animal: a value stock that’s priced like a growth stock.
At $58.72, where the stock closed Thursday, Merck shares were trading at 39 times trailing 12-month earnings, compared to an average of 16.1 for the other 29 Dow stocks. The closest is Nike (NYSE: NKE) at 26.2, and analysts project its earnings to grow by 13.35% per year for the next five years.
Merck’s PE says that investors are expecting an upside earnings explosion in the foreseeable future. Yet, Wall Street isn’t confirming that view: analysts’ consensus estimate is that MRK stock earnings will grow at an uninspiring rate of 4.03% a year.
And still, eight of the 19 analysts who cover Merck call the stock a “Buy” or “Outperform” and all the rest say “Hold.”
MRK stock pays a respectable dividend of $1.76 a share, for yield of 3.1%. A key ratio I use to assess whether the market is asking an unreasonable price for a stock is if one takes its dividend yield and estimated 5-year earnings growth rate into account.
It’s called the dividend-adjusted PEG (Price to Earnings Growth Rate), and Merck’s is 2.21, also the highest on the Dow and one that almost screams “sell me!”
What makes both me and Wall Street so optimistic about MRK stock? First, it’s rung up four straight quarters of earnings growth, the last, reported this past week, surprising analysts by four cents at 85 cents a share.
Second, that 12-month improvement supports Wall Street’s consensus that for all of 2014, Merck’s earnings will be $3.49 per share, more than double 2013’s $1.47.
The latest earnings were driven by a 19 percent quarter-over-quarter increase in sales of its consumer products and healthy gains in several of its key patented drugs, including its anti-arthritis drug Remicaid (up 15%) Isentress (up 10%), used to treat HIV infections, and its human papillomaovirus vaccine, Gardasil (up 7%).
But what’s really making investors drool are Merck’s prospects for some nine potential blockbuster drugs now in various stages of development.
These include Pembrolizumab, an investigational drug to treat advanced melanoma, which is Phase III trials and which has FDA granted “breakthrough status.” Merck CEO Ken Frazier says Merck is studying the possible application of the drug to treat 30 different kinds of cancer. It’s expected to reach the market later this year.
These are the kinds of drugs Merck needs to make up for the revenue losses it suffered from mature blockbusters that have since lost patent protection and given birth to less expensive generics. But the problem is that the impact of these drugs on Merck’s income statement are unknown, which is why analysts still project mediocre earnings growth head. It’s all a wee bit speculative.
Nevertheless, MRK stock is going to deliver on some of these drugs and they will add materially to the bottom line.
My projection is that investors could expect an average total return of about 7.7% over the next gives. That’s based on the current analyst consensus for earnings growth, and no growth in dividends. That’s an attractive growth rate for a stalwart, as Peter Lynch would say, so at the very least, I think this is a good buy for income or retirement investors.
If you lack a few stalwarts in your regular portfolio, you could do a lot worse.
Lawrence Meyers does not own shares in any company mentioned.
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