The Dow Ends the Week at Record Highs; Why Did Merck and Pfizer Fall the Most?

Record highs are worthy of celebrating, but the Dow's pharma stocks are lagging badly.

May 10, 2014 at 5:04PM
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Over the past week, the Dow Jones Industrials (DJINDICES:^DJI) gained 70 points, hitting a new high on Friday to mark the second all-time record close in 2014 for the Dow. As geopolitical risk from Russia and Ukraine took an important step toward potential de-escalation and as signs of economic stability and growth continued to appear, the stock market reacted favorably. But for Merck (NYSE:MRK) and Pfizer (NYSE:PFE), the Dow's gains have been irrelevant, with both stocks dropping around 5% in just the past week.

Blood Sample
Source: U.S. Navy, Wikimedia Commons.

The pharma blues
Both Merck and Pfizer are going through some major transformational events, and despite what's happening to their respective share prices, not all of those events are inherently negative in tone. Merck announced Tuesday that it would sell off its consumer-care business to Germany's Bayer for $14.2 billion, addressing at least some of the concerns of investors who argued that Merck needed to make more moves toward restructuring its massive operations in order to keep up with rival Pfizer. For its part, Pfizer has more aggressively made corporate shifts, with the spinoff of its animal-health business being just one of the ways Pfizer has tried to streamline its operations.

One question that came up this week is whether Merck might also try to make another similarly sized massive business sale. As Fool analysts David Williamson and Michael Douglass discussed Monday, Merck is rumored to be trying to sell its established-products unit, which includes drugs that have come off-patent, for as much as $15 billion. That could give Merck a $30 billion war chest to use to improve its competitive position.

Pfe

Yet investors might justifiably be worried about what comes next once Merck has all that cash. Pfizer marks one example of what can happen in today's pharma M&A environment, with its massive attempt to buy out AstraZeneca setting price tags well in excess of $100 billion. Yet even a 12-figure buyout isn't enough for Astra management, who argue that the British drug company has plenty of prospects as an independent company. Pfizer has already had to up its bid once, and the fear that having a lot of available cash -- or a well-valued stock to use as currency -- will prove too much to resist even if it requires paying premium prices. Especially if the Pfizer deal goes through, the temptation for Merck to keep pace with a big acquisition of its own might well prove overwhelming -- and disastrous for shareholders in the long run.

The big takeaway you should draw from Pfizer's and Merck's declines this week is that the pharmaceutical industry is getting more dangerous, and companies have to take bigger risks in order to reap bigger rewards. For those who see Merck and Pfizer merely as solid dividend stocks, that's a wake-up call that should make you think twice about your thesis for owning their shares.

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Dan Caplinger and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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