Better Buy: Merck & Co., Inc. vs. Pfizer

By Markets Fool.com

Pharmaceutical companies have been in the news lately, and political pressure attacking the profits that drug-makers have earned over the decades is rising rapidly as the 2016 election approaches. For pharma giants Merck (NYSE: MRK) and Pfizer (NYSE: PFE), however, the fear of potential new regulation hasn't led to a big decline in their share prices over time, and the growth trends toward greater use of pharmaceuticals both in the U.S. and around the world remain positive catalysts for further stock gains in the future. Investors looking at drug stocks are curious which of these two blue-chip stocks looks like a smarter pick right now. With that in mind, let's compare Merck and Pfizer on a number of metrics to see which makes more sense right now.

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Valuation and stock performance

Both Pfizer and Merck have seen their stocks rise over the past year. Merck has managed to post stronger gains, rising 23% compared to a total return of just 7% for Pfizer.

When you look at simple valuation methods based on trailing earnings, neither Merck nor Pfizer look particularly inexpensive. Merck trades at 34 times its earnings over the past 12 months, and while Pfizer is a bit less expensive, its earnings multiple of 30 is still well above the overall market average. When you incorporate future expectations for earnings, however, both stocks begin to look cheaper. Using future estimates for earnings, Pfizer trades at just 13 times forward earnings, and Merck also looks more reasonable with a forward earnings multiple of 16. Pfizer's valuation is slightly cheaper than Merck's, which makes sense given Pfizer's smaller share-price advance compared to its rival.

Dividends

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For dividend investors, both Merck and Pfizer look good. Again, though, Pfizer beats out its competitor, posting a 3.5% dividend yield compared to Merck's current payout of slightly less than 3%. The temporarily depressed earnings that both companies have seen lately raise concerns about the sustainability of the dividend, given that both Merck and Pfizer have payout ratios at or slightly above 100%. Based on future expectations, however, it's likely that those figures will drop for both companies going forward.

In terms of dividend increases, Pfizer has been more generous recently as well. Its most recent dividend increase earlier this year added 7% to its quarterly payout, compared to just a 2% increase late last year from Merck. That's consistent with the two companies' longer-term history, in which Pfizer has typically rewarded shareholders with faster dividend growth. On the dividend front, Pfizer has an edge over Merck.

Growth prospects and risk

Fundamentally, Merck and Pfizer have enjoyed similar long-term success but also have to deal with many of the same obstacles to future growth. In Merck's most recent quarterly report, the company reported sales growth of just 1%, reporting that the strength of the U.S. dollar cost it two percentage points of growth. Adjusted net income climbed about 6%. Merck focused its attention on key drugs like cancer-fighter Keytruda and hepatitis C treatment Zepatier, which it hopes to attain blockbuster status and replace some of the compounds that have gone off-patent over the years. Acquisitions continue to play a vital role in driving growth in pipelines for Merck, but the drug-maker has had to deal with restructuring costs and impairment charges that forced it to cut its earnings guidance for the full year, and falling sales for past blockbusters requires Merck to stay vigilant looking forward.

For Pfizer, you'll find some of the same issues. In its most recent quarter, Pfizer's sales jumped 11%, but much of that growth came from the inclusion of Hospira in its consolidated results. Reported profits fell, although the bottom line improved on an adjusted basis. The company is also focused on its pipeline, and the August announcement that Pfizer would purchase Medivation in a $14 billion deal showed how strongly Pfizer believes in growing its scale even further. As CEO Ian Read noted, the move "will strengthen Pfizer's Innovative Health business and accelerate its pathway to a leadership position in oncology, one of our key focus areas." Some fear that Pfizer had to overpay for Medivation, but the purchase price was consistent with premium values for acquisitions in the healthcare space recently.

Overall, Merck and Pfizer have similar opportunities and challenges. As a result, Pfizer's cheaper valuation and higher dividend yield make it look more attractive than Merck for most investors right now.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.