A look at Merck’s valuation
On May 9, 2016, Merck & Co. (MRK) was trading at a forward PE (price-to-earnings) multiple of ~14.4x, compared with the industry average of 18.9x. Over the last year, the company’s forward PE has been 13.0x–17.0x. It’s trading at a higher PE than Pfizer (PFE), which trades at 13.6x, and AbbVie (ABBV), which trades at 12.3x. Competitors Eli Lilly (LLY) and Johnson & Johnson (JNJ) are trading at higher PE multiples of 20.1x and 16.7x, respectively.
The fundamental factors affecting stock prices and valuation include the performance of growth platforms as well as the exclusivity of blockbuster drugs. Foreign exchange rates also play an important role in the profitability of the company and consequently affect stock prices and valuation. This series covers the segment-wise performance of products and the major drivers of this performance.
From an investor’s point of view, the two best valuation multiples for valuing companies such as Merck are forward PE and EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization), considering the relatively stable and visible nature of their earnings.
The PE multiple represents what one share can buy for an equity investor. Based on the last five years’ multiples, Merck’s current valuation is neither high nor low, and its PE multiple has been 7.8x–18x. Merck’s valuation multiple has also followed the industry’s overall trend over the last five years. Whether the healthcare sector’s forward PE multiple rises or falls, Merck will definitely be affected.
On a capital structure neutral and excess cash-adjusted basis, Merck currently trades at ~10.3x. That’s much lower than the industry average of ~14.0x. Pfizer (PFE), AbbVie (ABBV), Eli Lilly (LLY), and Johnson & Johnson (JNJ) have forward EV-to-EBITDA multiples of 10.1x, 10.5x, 14.5x, and 11.4x, respectively.
Merck’s stock price has fallen nearly 5.8% over the last 12 months. Analysts’ estimates for the stock have a potential return of 12.2% over the next 12 months. Analysts’ recommendations show a 12-month target price of $61.34 per share compared to $54.68 per share on May 10, 2016.
About 46% of analysts are recommending a “buy,” while ~54% are recommending a “hold,” according to a Bloomberg consensus. Changes in analysts’ estimates and recommendations are typically based on changing trends in the stock price.
In order to divest your risk, you can consider ETFs such as the SPDR S&P Pharmaceuticals ETF (XPH). It holds ~4.6% of its total assets in Merck. The iShares US Healthcare ETF (IYH) holds ~5.5% of its total assets in Merck.
In the next part of the series, we’ll see what factors are impacting Merck’s growth.