Investing for income may never be the most exciting investment strategy in the world. But as long as a company doesn't cut or suspend its dividend, it can be a profitable approach -- and some dividend payers can provide growth, too.
Merck (MRK 0.37%) shareholders have done quite well on that front. A $5,000 investment made five years ago would be worth $9,700 today with dividends reinvested. This is more than the $8,600 that the S&P 500 index would have turned the same investment amount into during that time.
And the pharmaceutical stock, which is a Dow Jones Industrial Average component, continues to look like a good buy for investors today. Let's analyze Merck's fundamentals and valuation to understand why.
Blockbuster medicines are driving healthy growth
Few drugmakers take innovation as seriously as Merck. After all, the company spent $13.5 billion on research and development in 2022 -- just under 23% of its $59.3 billion in total revenue reported during the year. Including oncology drug Keytruda and human papilloma virus vaccine Gardasil, Merck has seven products poised to surpass $1 billion each in sales in 2023.
| Merck's Top-Selling Products | Q2 2023 Sales (in Millions) |
|---|---|
| 1. Keytruda | $6,271 |
| 2. Gardasil | $2,458 |
| 3. ProQuad/M-M-R II/Varivax | $582 |
| 4. Januvia | $511 |
| 5. Bridion | $502 |
Data source: Merck.
The New Jersey-based company's total sales grew by 3% over the year-ago period to $15 billion in the second quarter ended June 30. Taking foreign currency exchange headwinds into account due to the robust U.S. dollar, the company's total currency-neutral sales would have risen by 7% during the quarter.
These results were made possible by currency-neutral sales growth in five of Merck's seven blockbuster products, ranging from 1% for its ProQuad/M-M-R II/Varivax vaccine franchise to 53% for Gardasil. The growth in these products more than offset the respective 30% and 23% year-over-year sales drops in diabetes medicines Januvia and Janumet for the quarter. Sales of these products shrank due to generic competition in Europe and lower pricing in the U.S.
Merck recorded a non-GAAP (adjusted) net loss per share of $2.06 in the second quarter. But when backing out the acquisition charge for Prometheus Biosciences of $4.02 per share, adjusted diluted earnings per share (EPS) grew by 4.8% over the year-ago period to $1.96. Merck's acquisition of this biotech, which focuses on treating immune-mediated diseases, bolsters the immunology therapy area of its pipeline. Through this acquisition, the pharma giant gains a promising drug candidate for ulcerative colitis and Crohn's disease referred to as PRA-023 by Prometheus.
Thanks to both the internal development and acquisition activity, Merck has well over 100 projects that are currently in phase 2 or phase 3 clinical trials. One of the more exceptional products in its pipeline is the pulmonary arterial hypertension drug candidate known as sotatercept, which could achieve annual peak sales of between $3 billion and $4 billion. That is why analysts believe its adjusted diluted EPS will rise by 9.4% annually for the next five years. Put into perspective, that is better than the industry peer consensus of 8.5%.
Image source: Getty Images.
A payout with solid growth prospects
In comparison to the S&P 500 index's 1.5% dividend yield, Merck's 2.8% yield is rather appealing. This is especially true when considering that the quarterly dividend per share has rocketed 52% higher in just the past five years.
Better yet, mid- to high-single-digit annual dividend growth should continue moving forward. That is because the company's dividend payout ratio is positioned to come in at just 41% for 2023 (not counting the Prometheus acquisition charge). This leaves Merck with the capital needed to capitalize on growth opportunities and further shore up the balance sheet.
The valuation is a steal
Having surged 21% higher over the past 12 months, shares of Merck have momentum on their side, just like the business. Fortunately, the stock appears to offer yet more value for income investors: Merck's forward price-to-earnings (P/E) ratio of 12.4 is below the drug manufacturer industry average of 13.3.
As a result of its above-average growth potential and below-average valuation, analysts have an average 12-month share price target of $125 -- 19% upside from the current $105 share price. This makes the stock a great buy for income investors in my opinion at this time.
