Fool Buys MRK
August 04, 1994

Merck & Co.
TYPE: Beating the Dow
Phone: (908) 594-4000
Closing prices, August 4th, 1994: Bid $29 7/8, Ask $30

Trailing 12-month revenues: $12.9 billion
Trailing 12-month EPS: $2.39
Last quarter reported: June 1994 (FY: Dec)
Next quarter reported date: October 18, 1994
Consensus EPS estimates for quarter: $0.63e vs. $0.62

FOOL ratio: N/A

Trade: Buying 165 shares, August 5th

Merck & Co., located in Whitehouse Station, New Jersey, is a behemoth American drug company, one of the 30 Dow Jones Industrial Average stocks. Readers familiar with Michael O'Higgins's Beating the Dow investment approach---responsible for American Express and Sears's coming presence in our portfolio---may recognize this Foolish pick as another O'Higgins special.

EARNINGS SLEEPER. Merck is projected to come in with 10-15% earnings growth over the next 18 months. No matter how Foolish you are, that's nothing to get excited about, particularly when you recall that Merck's annualized growth rate over the previous five years exceeded 20%.

But in Merck's case, The Fool would like to challenge an old notion by asking, "Should this company be valued off its earnings?" Though the answer is not a pure "no," it's less of a "yes" than ever before, now that Merck has entered the generic drug market. In the generic drug market, market share is king. We view the move as an excellent one for Merck, with its fine reputation and strong name-recognition.

STILL TIED DOWN. Wall Street seems less interested right now in Merck's future prospects than in its present condition. And the present condition includes an unsure health bill, government hostility toward drug makers, and a thick blue cloud of gloom that has crept over MRK stock for many moons now. It's been a discouraging year for Merck shareholders, whose investment is trading nearly 25% off its yearly highs at present, after having fallen from $45 at the beginning of 1993.

Wall Street always overreacts---that's one of our axioms. And Wall Street continues to view potential governmental intervention in medical care as highly likely and a total disaster. Despite our being just across the river from Congress, we have no idea what's going to happen with the health bill. But we do know a couple of things. One is that the government's not going to take out one of the princes of American business. Another is that Merck teamed up with Medco Containment is a medical-products blockbuster. Oh, and then there's the dividend.

THE DIVIDEND YIELD. Over the next year, Merck has declared it will be pay a dividend of $1.12 per share. Dividing this amount by the share price gives you the "dividend yield," now 3.7%. As of this writing, 3.7% is about one-and-a-half percent more than you'll get at your local bank. That's one good reason to hold the stock, and one good reason to expect that others will want to hold it as well.

The dividend yield, effectively the interest rate you receive for holding a company's shares for one year, serves another important role---it provides bolster for a share price. If Merck's stock were to decline from here, the $1.12 per share dividend would grow ever more attractive. If MRK drops to $25, for example, the dividend yield would grow to 4.5% ($1.12 divided by $30 = 4.5%). At that level, some investors will start snapping up the stock for the yield alone.

FOOLISH OUTLOOK. We believe that Merck is a safe and firm holding at its present price, giving you about 4% in interest over the next year, and highly likely to produce some capital gains for you as well. Buy low, sell high, right? A high yield is usually the sign of a beaten-down stock, and we think that describes Merck very well. (Another unpopular high-yielder today is Philip Morris, which we also think makes a good investment.)

We're going to buy and hold MRK for a year. It looks like a Market-beater.