Has Merck Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Merck (NYSE: MRK  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Merck.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

14.8%

Fail

 

1-Year Revenue Growth > 12%

0%

Fail

Margins

Gross Margin > 35%

66%

Pass

 

Net Margin > 15%

14.2%

Fail

Balance Sheet

Debt to Equity < 50%

33.7%

Pass

 

Current Ratio > 1.3

2.32

Pass

Opportunities

Return on Equity > 15%

11.9%

Fail

Valuation

Normalized P/E < 20

19.65

Pass

Dividends

Current Yield > 2%

3.8%

Pass

 

5-Year Dividend Growth > 10%

1.55

Fail

       
 

Total Score

 

5 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Merck last year, the company has lost a point for the second year in a row. Flat revenue was the culprit, but the stock is still up 30% over the past year as investors get used to its future prospects.

Like many of its competitors, Merck has dealt with the loss of patent protection on several blockbuster drugs. With sales of Singulair and Remicade -- its leading and third-highest selling drugs, respectively -- down sharply, Merck has had to find other ways to replace lost revenue. A deal with Endocyte (Nasdaq: ECYT  ) that could pay the tiny biotech as much as $1 billion if certain milestone are met is just one example of the lengths to which Merck is willing to go to bolster its pipeline.

Moreover, Merck's off-patent drugs aren't the only ones at risk. Merck also faces litigation from producers of generics seeking to invalidate patents. Teva Pharmaceutical (NYSE: TEVA  ) , Impax Laboratories (Nasdaq: IPXL  ) , and Mylan (Nasdaq: MYL  ) are just a few of the many companies that have sued Merck over patents on various drugs, including Vytorin and Zetia.

But Merck has some promising irons in the fire. In the diabetes space, MK-3102 could add to the company's success with Januvia and Janumet. Insomnia treatment suvorexant also looks promising, with a successful phase 3 study in the books as the company waits for FDA approval, and Merck has also seen good results from a phase 2 trial of odanacatib, a potential treatment for osteoporosis.

For Merck to improve, it needs to get revenue moving back in the right direction. That's hard with patent losses, but with valuations having picked up lately, Merck needs to produce results to justify the premium that dividend-hungry investors are putting on its stock.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Learn more about Merck in our brand new premium research report today. Our senior biotech analyst Brian Orelli, Ph.D., walks you through both the opportunities and threats facing Merck, and the report comes with a full 12 months of updates. Claim your copy now by clicking here.

Click here to add Merck to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.


Read/Post Comments (0) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

DocumentId: 2126672, ~/Articles/ArticleHandler.aspx, 4/23/2014 10:56:26 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement