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Here is a look at how Merck & Co. (NYSE:MRK) fares in ModernGraham's opinion, based on an updated and modernized version of Benjamin Graham's requirements of defensive and enterprising investors from The Intelligent Investor:

Defensive Investor – must pass at least 6 of the following 7 tests: Score = 4/7

  1. Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
  2. Sufficiently Strong Financial Condition – current ratio greater than 2 – PASS
  3. Earnings Stability – positive earnings per share for at least 10 straight years – PASS
  4. Dividend Record – has paid a dividend for at least 10 straight years – PASS
  5. Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period – FAIL
  6. Moderate PEmg ratio – PEmg is less than 20 – FAIL
  7. Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – FAIL

Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 3/5

  1. Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 – PASS
  2. Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 – FAIL
  3. Earnings Stability – positive earnings per share for at least 5 years – PASS
  4. Dividend Record – currently pays a dividend – PASS
  5. Earnings growth – EPSmg greater than 5 years ago – FAIL

Valuation Summary (explanation of the ModernGraham valuation model):

Key Data:

MG Value $0 – Rare scenario. See Conclusion.
MG Opinion Overvalued
Value Based on 3% Growth $30
Value Based on 0% Growth $18
Market Implied Growth Rate 7.12%
Net Current Asset Value (NCAV) -$7.26
PEmg 22.73
Current Ratio 2.07
PB Ratio 2.90

Balance Sheet – 9/30/2013 (an Introduction to the Balance Sheet)

Current Assets $37,765,000,000
Current Liabilities $18,215,000,000
Total Debt $22,647,000,000
Total Assets $106,419,000,000
Intangible Assets $37,123,000,000
Total Liabilities $59,000,000,000
Outstanding Shares 2,926,610,000

Earnings Per Share – Diluted

2013 (estimate) $2.05
2012 $2.05
2011 $2.07
2010 $0.31
2009 $5.73
2008 $3.64
2007 $1.49
2006 $2.03
2005 $2.10
2004 $2.62
2003 $2.92
2002 $2.98

Earnings Per Share – Modern Graham

2013 (estimate) $2.07
2012 $2.30
2011 $2.50
2010 $2.69
2009 $3.59
2008 $2.47

Conclusion:

Merck & Co. presents a rare scenario for the ModernGraham valuation model. The company’s earnings growth has been so atrocious over the historical period the model reviews that the projected growth is that the company will continue to shrink its earnings. In fact, the EPSmg (normalized earnings) in 2008 was $2.47, but the estimated EPSmg in 2013 is only $2.07. Historically, the EPSmg has shrunk every year since 2009. As a result, the model forecasts negative earnings growth and churns out a valuation of $0. Obviously, the company probably isn’t worthless, but the Intelligent Investor would probably shy away from Merck anyway, based on the facts that the company failed to fulfill the requirements of either the Defensive or Enterprising Investor due to the poor earnings growth and high PB and PEmg ratios.

What do you think? Is Merck overvalued or does Mr. Market have it right? Should the company only be considered speculative? Leave a comment or mention @ModernGraham on Twitter to discuss.

Disclaimer: The author did not hold a position in Merck at the time of publication and had no intention of purchasing a position in the next 72 hours.

Source: ModernGraham Valuation: Merck & Co.