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 (MRK 2.42%) 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.

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 (TEVA -0.19%), Impax Laboratories (IPXL), and Mylan (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.

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