Benjamin Graham taught that Intelligent Investors must do a thorough fundamental analysis of investment opportunities to determine their intrinsic value and inherent risk. This is best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another company or by reviewing the 5 Undervalued Companies for the Defensive Investor Near 52 Week Lows – November 2014. By using the ModernGraham method one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries. What follows is a specific look at how Merck & Company (MRK) fares in the ModernGraham valuation model.
Company Profile (obtained from Google Finance): Merck & Co., Inc. (Merck), is a global health care company that delivers health solutions through its prescription medicines, vaccines, biologic therapies, animal health, and consumer care products, which it markets directly and through its joint ventures. The Company consists of four operating segments, which are the Pharmaceutical, Animal Health, Consumer Care and Alliances segments, and one reportable segment, which is the Pharmaceutical segment. The Pharmaceutical segment includes human health pharmaceutical and vaccine products marketed either directly by the Company or through joint ventures. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. On July 2, 2014, Santen Pharmaceutical Co., Ltd acquired certain ophthalmology assets from Merck & Co., Inc. On August 5, 2014, Merck & Co Inc (Merck) acquired Idenix Pharmaceuticals Inc (Idenix).
Defensive Investor – must pass at least 6 of the following 7 tests: Score = 3/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 – FAIL
- Earnings Stability – positive earnings per share for at least 10 straight years – PASS
- Dividend Record – has paid a dividend for at least 10 straight years – PASS
- 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
- Moderate PEmg ratio – PEmg is less than 20 – FAIL
- 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 = 2/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 – FAIL
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 – FAIL
- Earnings Stability – positive earnings per share for at least 5 years – PASS
- Dividend Record – currently pays a dividend – PASS
- Earnings growth – EPSmg greater than 5 years ago – FAIL
|Value Based on 3% Growth||$32.38|
|Value Based on 0% Growth||$18.98|
|Market Implied Growth Rate||9.01%|
|Net Current Asset Value (NCAV)||-$7.51|
Balance Sheet – September 2014
Earnings Per Share
Earnings Per Share – ModernGraham
Merck & Company does not qualify for either the Defensive Investor or the Enterprising Investor. The Defensive Investor is concerned by the low current ratio, lack of earnings growth over the last ten years along with the high PEmg and PB ratios. The Enterprising Investor is similarly concerned by the lack of earnings growth over the last five years along with the high level of debt relative to the net current assets. As a result, value investors following the ModernGraham approach based on Benjamin Graham’s methods should explore other opportunities at this time. From a valuation side of things, the company appears to be overvalued after seeing its EPSmg (normalized earnings) drop from $2.66 in 2010 to only an estimated $2.23 for 2014. This demonstrated lack of growth clearly does not support the market’s implied estimate of 9.01% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham’s formula, to return an estimate of intrinsic value well below the price.
Be sure to check out previous ModernGraham valuations of Merck & Company (MRK) for a greater perspective!
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects. What do you think? What value would you put on Merck & Company (MRK)? Where do you see the company going in the future? Is there a company you like better? Leave a comment on our Facebook page or mention @ModernGraham on Twitter to discuss.
Disclaimer: The author did not hold a position in Merck & Company (MRK) or in any other company mentioned in this article at the time of publication and had no intention of changing that position within the next 72 hours. Logo taken from Wikipedia for the sole purpose of identifying the company; this article is not affiliated with the company in any manner.