We believe the forward PE (price-to-earnings) and EV-to-EBITDA[1. enterprise value to earnings before interest, tax, depreciation, and amortization] multiples are two of the best valuation multiples to use when valuing Merck & Co. (MRK) and other large pharmaceutical companies, given the relatively stable and visible nature of their earnings.
PE multiples are widely available and represent what one share can buy for an equity investor. On October 26, 2016, Merck (MRK) was trading at a forward PE multiple of ~16.0x. Based on the last five years’ multiple range, Merck’s current valuation is neither high nor low. Over the past five years, Merck’s PE multiple has ranged from ~7.8x to ~18x.
Merck’s valuation multiple has also followed the industry’s overall trend for the last five years. Whether the healthcare sector’s forward PE multiple rises or falls, Merck will be affected.
The industry currently trades at a forward PE multiple of ~15.3x. Among its competitors, Johnson & Johnson (JNJ), Pfizer (PFE), and Eli Lilly (LLY) have forward PE multiples of 16.1x, 12.3x, and 19.7x, respectively.
On a capital structure–neutral basis, Merck currently trades at ~9.9x. This is much lower than the industry’s average of ~11.6x. Its competitors Johnson & Johnson (JNJ), Pfizer (PFE), and Eli Lilly (LLY) have forward EV-to-EBITDA multiples of 11.1x, 9.4x, and 13.7x, respectively.
The above multiples represent an improvement in estimates and valuations for Merck, which is a positive sign for the investors. Investors can consider the Fidelity MSCI Healthcare ETF (FHLC), which holds 5.3% of its total investments in Merck & Co., 8.8% of its total investments in Johnson & Johnson, and 6.7% of its total investments in Pfizer, in order to diversify any stock-specific risk.