Novice Investing - Merck Co

Date: Monday 13th 2008f October 2008 06:11:50 PM

Merck makes it mark 02/23/2005

By: Hari Wibowo

Industry background

What can I say about Merck (MRK)? Not a lot of people know about it unless you are one in three Americans who are taking some sort of drugs whether it is prescribed or not. To be brief, Merck is a giant pharmaceutical company that makes everything from cholesterol drugs to high blood pressures to arthritis drugs. Competitors include giant Pfizer, Eli Lily and the like.

Innovation is critical to the survival of pharmaceutical companies like MRK. Patents can last for years, enabling the company to charge extraordinary prices to compensate for the high research and development (R&D) cost. Once patent loses its exclusivity, generic competition will appear and eat into profit margin. The only way to counter this trend is to continuously produce innovative drug treatments that people need and gain exclusivity through patents.

Quarterly Current ratio that is greater than one and is stable or rising.

MRK	Sept 04	Jun 04	Mar 04	Dec 03
Current Ratio	1.28	1.37	1.28	1.20

Quarterly current ratio held relatively steady for MRK over the last four quarters. While this ratio is not stellar, the company can still satisfy its short term obligation.

The company have ample liquidity for at least a year. MRK also is a profitable companies for years. Therefore, low current ratio is not a sign of weakness but rather the ability of management to make use of its cash.

Fair value of the stock is 3% above current free risk interest rate (10 yr bond)

As of 02/22 2005, 10 yr bond yields 4.28%. The stock needs to yield 7% to give it a fair value. I believe that Earning per share for MRK is at its low point for fiscal year 2005. Therefore, I will do something different this time and use 2006 estimated earning to arrive at my valuation. Estimated earning for 2006, is predicted to be $3.14. Discounting it back one year (with discount rate of 5%), present value of that EPS is $2.99.

For a yield of 7%, fair P/E value for MRK is therefore 14.3. EPS for MRK for fiscal year '06 is predicted to be $2.99. You can look at the details of EPS calculation here.

With a fair P/E value of 14.3, the real price for MRK is therefore $ 42.8/share. Meanwhile, Cash per share for MRK is $3.13/share and Long Term Debt per share = $ 1.98/share.

Real price = stock price - (cash+ short-term investment) + long-term debt.

Stock price = $42.8 + $3.13 - $1.98 = $43.95/share.

50% potential stock price appreciation within a year.

Current price for MRK is $ 31.21/share. With a fair value of $43.95/share, MRK does not provide a 50% potential appreciation. The ideal buying price for 50% appreciation of MRK shares is $29.3/share.

Conclusion

I believe MRK represents a good buying opportunity should it dips below $29.20. I am well aware of the uncertainty regarding the Vioxx litigation but share price now is low enough for a good investment. I am basically looking for a turnaround in MRK in 2006 instead of a one year price appreciation.

For other related articles for our portfolio, please click here.

Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding Merck Co Inc.(MRK) or other securities.

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