Merck and Company, Inc. (NYSE:MRK) shares were hitting new 52-week highs not that long ago, but then the fear over a dividend tax increase and year end tax-loss selling helped to push the stock lower. This has created another buying opportunity, even though the stock has started to climb up from recent lows of around $40.
Merck is one of the world's largest manufacturers of vaccines, pharmaceuticals and other health products. Just as with most pharmaceutical companies, Merck has seen some patent expirations, but it has also continued to spend on the research and development required to find the next high-potential vaccine or blockbuster drug candidate. Vaccines could provide this company with solid growth potential and it already offers a wide range of products including: Proquad for measles, rubella and varicella, Gardasil for human pampilloma virus, Zostavax for zoster (shingles), and Afluria for influenza virus, which is timely now considering the current outbreak of influenza.
Merck shares look like an ideal buy for dividend income investors as it offers a yield of about 4%. This is attractive since the average stock in the S&P 500 Index (NYSEARCA:SPY) yields about half that, at around 2%. Merck's yield is also higher than what many bonds and other traditional savings options provide. Plus, Merck has recently been slowly but surely increasing the dividend and that trend could be poised to continue. For example, Merck's dividend was 38 cents per quarter in 2011, but it has risen to 43 cents per quarter, which is an increase of nearly 15% in just a couple of years.
Another important factor is that earnings easily cover the dividend payout by a wide ratio. For example, in the third quarter of 2012, Merck reported non-GAAP earnings of 95 cents per share. That means the dividend payout ratio is just around 35%, leaving the company with plenty of room to raise the dividend, especially as earnings grow.
Analysts expect Merck to earn about $3.69 per share in 2013. That puts the price to earnings ratio at just over 11 times, which is cheap considering that the S&P 500 Index average is now around 15 times earnings. With investor interest in dividend stocks likely to remain high due to low interest rates, and with the stock looking undervalued now, it makes sense to consider Merck shares before it potentially rebounds further. Analysts at MKM Partners recently set a $51 price target for Merck. That potential upside is worth waiting for, especially since investors are paid a 4% yield while waiting.
Here are some key points for MRK:
Current share price: $42.87
The 52 week range is $36.91 to $48
Earnings estimates for 2012: $3.80 per share
Earnings estimates for 2013: $3.69 per share
Annual dividend: $1.72 per share which yields 4%
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.