Stay Away From Merck

Jul. 9.12 | About: Merck & (MRK)

Merck & Co Inc. (NYSE:MRK) is a large pharmaceutical company that manufactures products, which treat a wide range of conditions. Its consumer products division has well-known brands such as Claritin and Dr. Scholls. The company also sells a variety of vaccines. The largest competitors for Merck are Pfizer Inc. (NYSE:PFE) and Eli Lilly and Company (NYSE:LLY).

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MRK ChartClick to enlarge

MRK data by YCharts

Merck currently trades at $41.51 per share and has a 4.05% dividend yield. Pfizer has a similar yield of 3.9%, while Eli Lilly has a higher yield of 4.59%. Of course, yield is only one half of the dividend picture. Equally important for any dividend stock is the dividend growth rate. Here is the ten-year dividend history for Merck.

Year Dividend Growth
2002 $1.42 2.90%
2003 $1.46 2.82%
2004 $1.50 2.74%
2005 $1.52 1.33%
2006 $1.52 0.00%
2007 $1.52 0.00%
2008 $1.52 0.00%
2009 $1.52 0.00%
2010 $1.52 0.00%
2011 $1.56 2.63%
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Merck's dividend growth has been abysmal. In years where the dividend grew, it was by less than 3%, and 5 out of 10 years, the dividend didn't grow at all. By contrast, Pfizer has grown its dividend at a much higher rate over the past 10 years, which I pointed out in my article on Pfizer here. I'll calculate the payout ratio as a percentage of free cash flow. The results are shown below.

Year Free Cash Flow (Mil $) Float (Mil Shares) Payout Ratio
2002 $7,159 2,277 45.16%
2003 $7,947 2,253 41.39%
2004 $7,073 2,226 47.21%
2005 $6,206 2,200 53.88%
2006 $5,785 2,188 57.49%
2007 $5,988 2,193 55.67%
2008 $5,273 2,145 61.83%
2009 $1,931 2,273 178.92%
2010 $9,144 3,120 51.86%
2011 $10,660 3,094 45.28%
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The payout ratio has consistently hovered around 50%, with the exception of 2009, and this value is completely reasonable and sustainable.


I will use the Dividend Discount Model to put an estimated value on the company. This model assumes that the value of a company is purely the sum of all future dividends discounted back today. This is a reasonable valuation method if you are a dividend investor. The discount rate should be your required rate of return, and I will use a discount rate of 8%, which is roughly the long-term growth rate of the market as a whole. I will assume that the dividend will grow at a rate of 3% in perpetuity. Using these parameters, I arrive at a fair value estimate of $32.14 for a share of Merck.


Merck has a high yield of just over 4%, but almost nonexistent dividend growth. The graphic below shows how both yield and growth combine to determine the value of the stock.

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For Merck to be fairly valued, the dividend would have to grow at a rate of about 5.5%, which is well above the historical rate. At about $42 a share, Merck is significantly overvalued and is a stock that dividend investors should stay away from. Pfizer is a far better choice.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.