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The pharmaceutical sector has been an extremely lucrative industry over time, allowing investors to profit from the development of treatments that have improved the quality of life for billions of people across the globe. Among pharmaceutical companies, Merck & Co. and AbbVie have been two of the most successful and profitable over the long run, and their share prices have posted impressive long-term returns for shareholders. More recently, though, the pharmaceutical sector has come under fire from lawmakers and consumer advocates who argue that the balance between medical need and corporate profits has swung too far away from what the general public wants. As a result, many stocks in the industry have pulled back, and value investors want to know which of the Big Pharma stocks could be the most attractive right now. Let's look more closely at Merck and AbbVie using a range of common metrics to evaluate their merits.
Stock performance and valuation
The pharmaceutical industry hasn't been among the top performers lately, and both Merck and AbbVie have lost ground over the past year. Merck's decline has been relatively modest, producing a 2% loss on a total return basis since June 2015. AbbVie has done worse, falling 14% over the same timeframe.
Ordinarily, when one stock falls more than another, you can expect that its shares will become a better value. A quick look at earnings on a trailing basis confirms that idea in the case of Merck and AbbVie. After its recent decline, AbbVie now trades at 18 times trailing earnings, and although that's not particularly cheap compared to the broader market, it's not unreasonably high. By contrast, Merck trades at a trailing earnings multiple of 34, almost double what AbbVie fetches right now.
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When you look to incorporate expectations about future earnings into the equation, the gap narrows, but AbbVie still retains a cheaper valuation. Based on forward estimates, Merck's stock price is about 15 times expected future earnings. AbbVie, on the other hand, trades at a forward earnings multiple of less than 11. Even though AbbVie has seen its stock lag recently, its earnings multiples make it a somewhat more compelling investment than Merck solely on a valuation basis.
One of the attractive elements of the pharmaceutical industry is that it tends to produce solid cash flow, and the companies in the industry tend to return much of that cash flow to investors in the form of dividends. Both AbbVie and Merck have very attractive dividends right now. Merck's stock currently yields 3.3%, while the dividend yield for AbbVie is even higher at 3.8%.
Yet even though current yield is valuable, it's even more important for a stock to demonstrate that it can give its shareholders even larger dividend payments in the future. AbbVie has the prestigious status of being a Dividend Aristocrat, having inherited the long history of more than 40 years of annual dividend increases from former parent Abbott Labs. Since becoming a separately traded company in 2013, AbbVie has boosted its dividend four times and now pays a more than 40% higher dividend than it did three years ago.
Merck hasn't been as consistent with its dividend increases, and the boosts it has made haven't been as large. For instance, Merck went from 2004 to 2011 without increasing its dividend at all, using capital instead to do stock buybacks and to finance acquisitions. Since 2011, the company has made annual dividend increases, but they've been minimal at just a penny per share each year. Based on these factors, AbbVie looks better from a dividend standpoint than Merck.
Growth prospects and risk
In pharma, growth comes from new products, and the risk is always that a promising treatment won't survive the rigorous clinical trial process. Both Merck and AbbVie have their share of strong potential and sizable risk. In Merck's most recent quarter, for instance, the company saw sales of its key diabetes drug franchise Januvia and Janumet rise 1%, reversing course from a sales drop in the previous quarter. Cancer treatment Keytruda also pushed higher, and declines in past blockbuster Singulair were limited to just 3%, stabilizing from bigger losses in the past. However, the recent launch of hepatitis C treatment Zepatier hasn't gone nearly as well as expected, with Merck reporting just $50 million in the once-daily oral medication in the first quarter. Even with the disappointing launch, though, Merck boosted its guidance for revenue and earnings for the full year.
For AbbVie, the Humira franchise has been a key element of its long-term success, and it has also been a substantial source of risk as its initial patent expiration loomed. By taking steps to keep potential biosimilar treatments of the market for more than five years into the future, AbbVie has worked hard to protect the profit potential from Humira. However, other possible weak spots exist in AbbVie's list of offerings, including hepatitis C drug Viekira and leukemia and lymphoma treatment Imbruvica. Moreover, from a financial standpoint, AbbVie has aggressively turned to acquisitions to bolster its list of approved products and pipeline of future drugs, and that has put nearly $32 billion in debt on its balance sheet. That's more than Merck has even though AbbVie is much smaller, and that leverage arguably puts AbbVie's risk profile somewhat higher than Merck's.
From an overall standpoint, both Merck and AbbVie have pros and cons. AbbVie's higher dividends and cheaper valuation reflect the higher risk involved, while Merck offers considerable income opportunities with growth prospects as well despite its higher valuation. For those with a risk tolerance that can support it, going with AbbVie looks like the slightly better buy under current conditions.
The article Better Buy: Merck & Co. Inc. vs. AbbVie originally appeared on Fool.com.
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