Should Income Investors Buy This Dow Jones Stock?

There’s no guaranteed way to become rich, but buying quality businesses and holding them for the long run is arguably the safest way to do so.

Load Error

Global pharmaceutical giant Merck (NYSE: MRK), a regular among the world’s most admired healthcare companies, arguably fits the profile of a wonderful business. And its shares have doubled in value over the past five years — far outstripping the broad market indices.

But is this Dow Jones Industrial Average component right for investors’ portfolios today? Let’s assess Merck’s fundamentals and valuation to address this question.

A stacked product portfolio lifted sales higher

Since its founding in 1891, Merck has grown to become a juggernaut within the drugmaking industry. For context, the company’s $273 billion market capitalization puts it behind only Eli Lilly (NYSE: LLY) and Johnson & Johnson (NYSE: JNJ) in terms of size.

Merck’s sales edged 2.3% higher year over year to $13.8 billion during the fourth quarter, ended Dec. 31. Adjusting for the unfavorable foreign currency translation stemming from a strong U.S. dollar and Merck’s extensive international presence, sales were up 8%. What was behind the company’s sales growth in the quarter?

Merck’s portfolio consists of five blockbuster medicine franchises and two blockbuster vaccine franchises. This was led by the likes of the cancer drug Keytruda, the Gardasil human papilloma virus vaccine, and the COVID-19 antiviral treatment Lagevrio. Out of these seven products, the only one that saw a currency-neutral sales decline was the diabetes drug franchise Januvia/Janumet. This explains how the company’s sales moved upward in the quarter.

However, the bottom line didn’t fare as well. Merck’s non-GAAP (adjusted) diluted earnings per share (EPS) in the fourth quarter dipped 10.5% over the year-ago period to $1.62. The company’s non-GAAP net margin fell 410 basis points year over year to 29.9%. This, along with a 0.5% increase in Merck’s diluted share count, explains how its adjusted diluted EPS declined while sales grew in the quarter.

On top of its exceptional product portfolio, the company’s pipeline consists of more than 100 programs in late-stage clinical trials. This is why analysts believe that Merck will deliver 8.9% annual adjusted diluted EPS growth through the next five years. Adding some context to this figure, that is far superior to the drug manufacturer industry average earnings growth outlook of 6.4%.

The dividend is poised for future growth

Merck’s 2.7% dividend yield is much greater than the S&P 500 index’s 1.6% yield. And the best part is that more payout boosts should be on the horizon for shareholders. This is because it is projected that Merck’s dividend payout ratio will clock in below 43% in 2023.

That should give the company the ability to complete bolt-on acquisitions and reduce debt moving forward. This is why I believe that Merck will have no difficulty delivering mid- to high-single-digit annual dividend growth over the long haul.

Merck is cheaply valued

Shares of Merck have rocketed 42% higher over the last year, but the stock still looks to be discounted. Merck’s forward price-to-earnings (P/E) ratio of 12.7 is under the drug manufacturer industry average of 14.2. This is a great deal for a drugmaker that is growing faster than its peers.

Sure, the company could face a patent expiration for Keytruda toward the end of this decade. However, this valuation multiple builds in a margin of safety for income and value investors. That’s what makes the stock a buy for 2023 and beyond.