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Merck and Pfizer -- A Review

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By ThyPeace
November 22, 2006

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It's been a month or a bit more since we looked carefully at the big drug companies, namely Merck (MRK) (http://www.merck.com/) and Pfizer (PFE) (http://www.pfizer.com/pfizer/main.jsp). I've tried to make a habit of checking the BMW screens on www.bmwmethod.com weekly for the last few weeks, and this week I noted that they were both there. They've been on and off the screens for some time, and the last time we talked about them I was not focused on their status, so didn't do any research. This time, I decided to look further. First off, here are their current BMW statistical numbers:

[See post for tables]

From this, both stocks appear to be at fire sale prices. Get 'em while the getting's good! (Note: Both prices are slightly up from what they were when the screens were run.) They pass my very first test, in that I understand what drugs are, why they're useful, and who generally needs them. So how about some number crunching? I found some interesting things while I was looking. Behind these numbers you'll find some pretty interesting pictures. Take a look at grahaminvestor's charts for the two companies, particularly earnings.

Pfizer's earnings per share (http://charts.grahaminvestor.com/PFE.php) bounce all over the map over the last five years. The general trend is up, with two years (2000 and 2003) a long way down. Merck, on the other hand (http://charts.grahaminvestor.com/MRK.php), has a much steadier earnings picture. Their earnings rose steadily until 2001, reached a peak then and 2002, and have declined steadily ever since.

(Note that I calculate earnings growth over 5 years, while Graham Investor's earning calculations are for the last 10 years. Over the last ten years, PFE's average EPS growth has been 9.05% and MRK's average EPS growth has been 3.28%.)

From these basic indicators, it also appears that Pfizer is the stronger (and larger, based on free cash flow) company. Although earning have taken a hit in some years, they don't appear to have a steady decline. In addition, Pfizer has greater net cash, which makes them more able to withstand a downturn in business. Finally, it appears that Pfizer, with generally positive growth, is much more fairly valued than Merck is. Their PE is better, and the Growth and Dividend to PE ratio seems considerably more rational. (In other words, PFE's historical return to the investor, including dividend and growth, has you making money instead of losing money.)
So let's go back and look at the actual charts of stock price and go a little deeper. Here, the picture is not so clear as the "fire sale" view that the raw statistical numbers might indicate. I like to look at the linear charts instead of the logarithmic ones for this part of my analysis, as it makes price aberrations much more apparent.

For PFE (http://invest.kleinnet.com/bmw1/stats20/PFE.html), the years from 1985 to 1995 were a relatively low-growth period with a CAGR between 12% and 13%. Interestingly, if you delete the history from then until today, you would expect they'd just continued to follow that growth rate, entirely oblivious to anything else that happened. Of course, other things did happen, and the stock bubble took their price up substantially. From a price of about $4 in 1994, PFE jumped to $47 or so in 2001 � the mythical 10 bagger. The price dropped after that, of course, as did all the stocks. Interestingly, though, PFE did not drop like a stone. It drifted as much as it dropped and seemingly followed earnings results more than anything else. (How rational.) The difficulty here is that the earnings are so choppy.

For MRK (http://invest.kleinnet.com/bmw1/stats30/MRK.html), the chart shows a relatively constant growth rate from 1975 to 1985. Using Grahaminvestor's chart (referenced above), it appears that the CAGR during that time frame was between 2% and 3%. Then growth accelerated in the late 80's and early 90's, with a peak in late 1991 or early 1992. (PFE also saw this peak, so I suspect it was an industry-wide or broader effect.) The price then dropped down to a number consistent with the decade's overall low points. And then the price took off like a rocket, jumping from the mid-teens in 1994 to over 90 in 2001. And therein lies the rub. That notorious bubble raised the price of many stocks that far � whether they deserved it or not. It may be that Merck did need to rise some; their earning in the early part of this decade were steadily increasing and things were going well for them. Merck gave back almost all of those gains from 2001 to 2005, when it was back down to the mid-20s. Since then, the price has once again been on the rise. If you look at the fall, there were three precipitous drops, the last in late 2004. The different in this last one is that the stock did not immediately recover; it bounced around its low for a while, rose a little, dropped back down, and then began to climb. When I look at earnings against stock price, it appears to me that the irrational exuberance of the late 90s was not really based on earnings, which were nice and linear during that time. When earnings flatlined 2002 and 2003 and then began to drop, the price had to adjust to both the previous runup and the new, less wonderful results. Hence the pretty big drops in price. The earnings are, maybe, starting to show some improvement, with an up-down pattern over the last couple of years that isn't nearly as smooth nor steady as previous growth trends � it's much more similar to the choppy pattern PFE shows.

Overall, it appears to me that although both companies have strengths and may grow well, Pfizer has the stronger underlying business and, for whatever reason, a more rational price. If I were a rational person, I'd go with Pfizer because of that and I probably will. What's also worth noting is that Merck's more volatile price history may present opportunities for people with stronger stomachs than I have. I've never liked roller coasters � but for those who do, there may be another meteoric rise in Merck's future.


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