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Better Buy: Pfizer Inc. vs. Merck

By Dan Caplinger – Mar 5, 2016 at 9:03AM

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Both of these pharma giants have seen their shares slump lately. Which looks more promising?

Image source: Merck.

The pharmaceutical sector has taken political fire lately, and the presidential election has opened up drugmakers to criticisms about what they charge for their products. Pfizer (PFE -2.01%) and Merck (MRK -0.98%) have both seen their share prices fall back over the past year, but many still believe that the demographic trends toward increased healthcare demand will support their stocks over the long haul. Investors looking at the sector want to know which stock is a better buy right now. Let's compare Merck and Pfizer on a number of metrics to see which makes more sense right now.

Both Pfizer and Merck have seen their stocks lose ground over the past year. Pfizer is down 11%, which is slightly worse than Merck's 7% decline since early 2015.

Somewhat surprisingly, neither Merck nor Pfizer look all that attractive on a simple earnings-based valuation basis. Pfizer currently trades at 27 times trailing earnings, and Merck looks even more expensive with a trailing earnings multiple of 33. However, both Merck and Pfizer have taken substantial one-time charges for legal settlements, restructuring expenses, and other extraordinary items. On a forward-looking basis, the drugmakers' valuations look more reasonable, with Pfizer again looking slightly cheaper at 12 times forward earnings compared to 14 for Merck. Pfizer arguably has a slight edge on valuation, but the difference is fairly minimal.

For dividend investors, both Merck and Pfizer have strong records. Merck's current dividend yield is 3.7%, and Pfizer ekes out a slight edge with its 4% dividend yield.

From a sustainability standpoint, the fact that both companies' earnings are somewhat artificially depressed produces payout ratios above 100%. However, if earnings return to more normal levels as expected, then both Pfizer and Merck would have much more modest payout ratios.

Historically, Merck's dividend history has been less tumultuous than Pfizer's. Merck kept dividends unchanged from 2004 to 2011 as it integrated major acquisitions that demanded substantial amounts of cash, but it never reduced its dividend payout. Pfizer, on the other hand, maintained a much faster dividend growth rate during most of the 2000s, but the financial crisis led it to retrench and cut its dividend by half. Even with the cut, though, Pfizer has tripled its dividend since 2000, compared to a roughly 60% increase for Merck. Pfizer has the advantage over Merck on the dividend front.

Fundamentally, Merck and Pfizer face similar challenges. The strong dollar has hurt their overseas results, and the ongoing tug of war between declining sales of drugs with expiring patent protection and new pipeline drug candidates has continued. In Pfizer's most recent quarter, the drugmaker grew its sales by 7%, but adjusted net income was down slightly from the year-ago period. Sales of the Prevnar 13 vaccine more than doubled, but declining sales from Lipitor showed how the loss of former blockbusters can have a major impact on revenue. Full-year guidance of $2.20 to $2.30 per share in adjusted earnings was below the consensus forecast among investors and also represented only marginal growth from 2015 figures. CEO Ian Read pointed to strong performance from approved drugs, advances in its product pipeline, and the acquisitions of Hospira and Allergan as contributing to growth in 2016.

Merck's fourth-quarter results showed fairly similar trends. Worldwide sales dropped 3% in response to a 7-percentage-point hit from foreign exchange, and adjusted earnings rose 7%. The key Januvia drug saw revenue fall 12% year over year, offsetting gains from Gardasil, and several other well-known drugs such as Remicade, Singulair, and Nasonex posted double-digit sales decreases as well. Merck hopes that newly approved treatments will pick up some of that slack, but it is also pushing forward with pipeline efforts as well as its vaccine and hospital acute-care business. Guidance for $3.60 to $3.75 per share in adjusted earnings for 2016 would be only marginally higher than 2015's $3.59 per share figure, but CEO Kenneth Frazier pointed to the potential for hepatitis C treatment Zepatier and tumor-fighter Keytruda to become blockbuster drugs in their own right.

Overall, Pfizer and Merck look relatively similar in terms of their fundamental business prospects. Slight advantages in dividend and valuation give the nod to Pfizer for those looking to choose between the two pharma giants.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. We Fools may not 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.

Stocks Mentioned

Merck Stock Quote
$108.93 (-0.98%) $-1.08
Pfizer Stock Quote
$49.71 (-2.01%) $-1.02

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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