Should You Buy the Dow — Merck

Today, were looking at Dow Jones Industrial Average component Merck (NYSE: MRK
). You know its a diversified medical conglomerate, but how diversified is it?
The Pharmaceutical segment provides therapeutic and preventive agents for the
treatment of human disorders in the areas of bone, respiratory, immunology,
dermatology, cardiovascular, diabetes and obesity, infectious diseases,
neurosciences and ophthalmology, oncology, vaccines, and womens health and
endocrine. Its Animal Health segment discovers, develops, manufactures and
markets animal health products (who knew?). The Consumer Care segment develops,
manufactures and markets over-the-counter products for common ailments. The key
driving factors regarding MRK are research and development, the economy and
competition. R&D is one of the major reasons the company purchased
Schering-Plough a few years back. For serious diseases that require
pharmaceutical intervention, the economy isn't much of a factor, but it
certainly is with regards to Mercks over-the-counter products. Even worse, Merck
faces competition in this area as well (and with some of its pharmaceuticals).
So it helps that Merck is so large and generates a lot of cash to sustain its
R&D and dividend. Stock analysts looking out five years on Merck only see
annualized earnings growth at 4.5%. At a stock price of $32, on FY 2011 earnings
of $3.73, the stock presently trades at a P/E of 8.5. Pfizer (NYSE: PFE ) and
GlaxoSmithKline (NYSE: GSK ) are the closest competitors, with P/Es of 17 and
22, respectively, so Merck is very much on the low end of the valuation scale.
Merck's financials are solid. The company carries $14 billion in cash and
$15.7 billion in low-interest debt. Trailing 12-month cash flow was $9 billion,
which is twice the amount of free cash flow necessary to pay its 4.7% dividend.
Merck makes a lot of money and reinvests that cash right back into its R&D units
to find the next blockbuster drug. No insider purchases have been made in a long
time, which is discouraging but not unexpected for a company this ancient.
Conclusion Merck's solid cash flow and history are enough for me to warrant
putting a 6 P/E on it, but on projected 2015 earnings of $5.21 per share
(factoring in the 4.7% compounded dividend yield reinvested), we get a price
target of $31. Thus, I see MRK as being fully valued without much upside. This
is the classic stock for a retirement account, but I'd dump MRK if you have it
in a regular account. I believe MRK is a sell for regular accounts. I believe
MRK is a buy for retirement accounts. As of this writing, Lawrence Meyers did
not own a position in any of the aforementioned stocks. Check out Lawrence
Meyers take on other Dow Jones stocks here .