Merck Beats, but It's Still a Disappointment

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

In September, the Federal Reserve surprised by not initiating the "taper" of its $85 billion monthly bond-buying program that everyone was expecting. No one is expecting a taper at this week's Federal Open Market Committee meeting, and that consensus view looks right on the money. Given limited visibility regarding new economic data, it would be madness for the Fed to act now. What does that leave to drive the stock market this week? In the era of quantitative easing, it's easy to forget that stock prices are related to earnings and fundamentals, but we are in the middle of the third-quarter earnings season.

Stocks are roughly unchanged this morning, with the S&P 500 up 0.15% and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) up less than a point as of 10:20 a.m. EDT.

Merck beats, but it isn't enough
The headline number isn't always the one the stock market is focusing on -- justifiably so in the case pharmaceutical company Merck (NYSE: MRK  ) this morning. Yes, Merck beat Wall Street expectations for its third-quarter earnings per share, notching $0.92 (ex-items) versus a consensus estimate of $0.88. However, it's the manner in which the company achieved the "beat" and the future outlook that concern investors.

Cost management, rather than revenue growth, was instrumental to the earnings beat -- revenue declined 4% year on year to $11 billion, short of Wall Street's $11.1 billion estimate. Moreover, revenue for type 2 diabetes drug Januvia, Merck's top seller, fell 5%; investors can expect more of the same in the future as six treatments that could compete with the drug may come to market over the next two years. This is the same drug the company said it would channel more of its resources into in an effort to please investors.

Merck has struggled to convince investors of the case for investing in its stock. As the following graph shows, the stock (blue line) has lagged its peers (represented by the AMEX Select SPDR Healthcare Index, red line) and the S&P 500 (orange line) by a wide margin this year:

MRK Chart

MRK data by YCharts.

Indeed, Merck has lagged the S&P 500 over the past 12-month, three-year, five-year, seven-year, and 10-year periods. Furthermore, if Andrew Baum of Citigroup is right, investors shouldn't expect a reversal in the trend; prior to today's earnings, he wrote in a client note that "Merck's belated attempts to restructure their R&D organization are encouraging, but we continue to expect material earnings disappointment compared with consensus forecasts."

Shares of Merck are down 2.4% so far this morning.

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