Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?

One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if Merck (NYSE: MRK) fits the bill.

The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.

Some of the most basic yet important things to look for in a stock are:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.

  • Margins. Higher sales don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.

  • Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.

  • Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.

  • Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.

  • Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Merck.


What We Want to See


Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 14.9% fail
  1-Year Revenue Growth > 12% 88.2% pass
Margins Gross Margin > 35% 62.7% pass
  Net Margin > 15% 17.9% pass
Balance Sheet Debt to Equity < 50% 32.6% pass
  Current Ratio > 1.3 1.60 pass
Opportunities Return on Equity > 15% 20.1% pass
Valuation Normalized P/E < 20 23.90 fail
Dividends Current Yield > 2% 4.3% pass
  5-Year Dividend Growth > 10% 0.1% fail
  Total Score   7 out of 10

Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.

Merck clocks in with a very respectable score of 7. But don't let that fool you; the company faces big challenges in the years ahead.

Merck shares the same tribulation as other big pharma stocks like Pfizer (NYSE: PFE) and Eli Lilly (NYSE: LLY): keeping its pipeline of drugs in development fresh and full. Sales of many of Merck's biggest products have stagnated or fallen recently, and it's clear that the company needs more blockbusters in its stable.

Fortunately, the company has some good prospects. Promising drugs target such areas as blood clot reduction, hepatitis C, osteoporosis, and insomnia. However, none of them is a sure thing, as existing drugs from sanofi-aventis (NYSE: SNY), Bristol-Myers Squibb (NYSE: BMY), and Vertex Pharmaceuticals (Nasdaq: VRTX) have a leg up on Merck and the rest of the competition.

In the meantime, Merck has solid financials and has rewarded patient investors with a steady and healthy dividend yield. Although its fastest growth days are definitely behind it, Merck deserves its place among the leaders of the pharmaceuticals industry.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

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