Volatility And Pullback Presenting An Opportunity With Merck
Summary
- Merck dropped almost 20% from its December peak to its February low and this put the stock in oversold territory.
- The company has solid fundamental indicators with the ROE and profit margin well above average.
- Sentiment toward the stock is skewed to the bullish side, but the indicators aren't at extreme levels of optimism.
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The selloff and volatility we have seen over the last few weeks is presenting some opportunities on quality stocks. We have seen stocks from every sector hit with massive selling with some industries getting hit harder than others. Looking through the charts of some of the top rated companies from a fundamental perspective, I isolated a handful of stocks that I felt were presenting investors with good buying opportunities. One such company was Merck & Co. (NYSE:MRK).
Looking at the chart for Merck we see that the stock peaked in mid-December and then fell almost 20% from the peak to the low last week. This selloff took the stock out of overbought territory on both the 10-week RSI and the weekly stochastic indicators.
We see that both of the overbought/oversold indicators hit oversold territory last week and that is the first time since November 2017 that both were in oversold territory at the same time. At that point in time the stock was trading down between $50 and $52.50 per share.
The stock rallied in December and in January '18, but it fell again at the end of January when the trade war really got started. The stock would pull back to the $50-$52.50 range once again before eventually taking off on a rally that saw the stock go up over 60%.
Something else that stood out on the weekly chart was how the stock pulled back to the 104-week moving average last week. From there the stock rallied toward the end of last week and in to this week. The trend line could act as support going forward.
Merck has Solid Management Efficiency Readings
While I believe the technical analysis of a stock is important in telling us when we should buy or sell a stock, I believe the fundamentals tell us what to buy. Merck is pretty strong fundamentally, but there are particular areas where the company looks really good.
One area is the return on equity which is at 50%. The average company's ROE is below 20% so Merck is among the top companies when it comes to its ROE reading. The company's profit margin is at 34.4% and that is also well above average. The average profit margin is probably in the 15% range, meaning Merck's is twice as high.
Merck has seen its earnings grow at a rate of 11% per year over the last three years and they increased by 12% in the fourth quarter. Analysts expect earnings to grow by 10% in 2020.
Revenue has increased at an average of 6% per year over the last three years and it grew by 8% in the fourth quarter. Estimates for revenue have it increasing by 6% in the current year.
One of the key components for Merck in the current year and for the next few years will be the success of its lung-cancer treatment drug KEYTRUDA. Some street estimates have the drug generating up to $20 billion in revenue by 2025. KEYTRUDA is still in the early stages of usage here in the states, but it has been used extensively in Japan and the success rates are part of the reason for the optimistic projections.
Another drug that could help boost earnings and revenue for Merck is GARDASIL, the vaccine against Human Papillomavirus (HPV). The drug has seen a success rate of nearly 100% in protection from nine different HPV types. The HPV virus is a well-known cause of cervical cancer. Sales of the drug jumped from $1.7 billion in 2014 to $3.2 billion in 2018 for an annualized growth rate of 16.7%. The bad news for Merck is that the demand has outpaced the supply and they warned that the growth could slow this year because of the supply shortage. The company announced plans to dramatically increase production in the next few years.
Sentiment is a Bit of a Concern
The sentiment indicators for Merck are one area of concern that I have. The analysts' ratings and the short interest ratio are both skewed to the bullish side. There are currently 17 analysts covering the stock with 14 "buy" ratings and three "hold" ratings. This puts the buy percentage at 76.5%. This is slightly above the average range for buy percentages, but not what I would call an extreme reading. I was a little surprised that there were only 17 analysts covering Merck, I would have thought there would have been at least 25 analysts covering the stock given its market cap.
The short interest ratio is at 2.4 currently and that is slightly below average. The average short interest ratio falls in the 3.0 range. Like we saw with the analysts' ratings, the ratio points to slightly more optimism than the average stock, but not what I would call an extreme level of optimism. The short interest did drop from 25.33 million shares to 22.56 million shares in the most recent report, so the optimism does appear to be increasing to some degree.
My Overall Take on Merck
I already expressed that I am bullish on Merck. The fundamentals are above average with the ROE and profit margin well above average. The earnings and revenue growth have been solid over the last few years and the success of KEYTRUDA could help propel these growth rates even higher in the coming years.
The technical picture shows how the stock hit oversold territory last week and now the RSI is out of oversold territory and the stochastic indicators made a bullish crossover. These signals suggest to me that the stock is ready for a bounce after selling off over the last few months.
My concerns for the stock are mostly centered around the sentiment indicators and the overall market environment. The sentiment is skewed to the bullish side, but not to an extreme level. I would like the stock even more if there was a little more pessimism being displayed toward the stock.
The bigger concern is the overall market environment. The panic selling we have seen over the last few weeks is a concern for all stocks in my opinion. Investors are concerned about the Coronavirus and the uncertainty over the impact it will have on the global economy. Merck itself shouldn't see too much of an impact since it is a pharmaceutical company, but that doesn't mean investors won't sell the stock.
The stock is trading at current P/E just over 21 and a forward P/E just below 16. This puts the stock in a pretty good position from a valuation standpoint. Another positive factor for the stock is the 3.0% dividend it pays.
I like the idea of buying Merck at its current level with a target of $100 over the next 12 months. That would mean a gain of approximately 25% over the next year. I would also suggest using caution with the stock. A stop in the $70 area would limit the loss to around 12%.
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This article was written by
Analyst’s Disclosure: I/we 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.
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Comments (8)
Your chart actually shows that for about 6 months the shares traded at prices below the long term moving average. Have sales at Merck increased almost 50% in two years? No but the price had. A drop in price of 20% from the high has only begun to reduce its excessive valuation.Pfizer on the other hand is not as oversold but is actually much cheaper. It has been trading below that same moving average now for months. Merck may rebound faster but PFE is cheaper.
