Last year was the first time since 2018 that the Dow Jones Industrial Average recorded a loss. Macroeconomic and geopolitical headwinds led the index to decline 8.9% in 2022. But not all Dow Jones components fared as poorly during that time: After two straight years of single-digit losses, share prices of the pharmaceutical company named Merck (MRK -0.06%) rocketed 49% higher in 2022.
After such a tremendous performance, one question comes to mind: Can Merck’s stock run it up again in 2023? Let’s assess Merck’s fundamentals and valuation to get an answer.
Merck is building a sustainable future
Investors probably know Merck best for its star oncology drug Keytruda. Thanks to regulatory approvals to treat 19 types of cancer in the U.S., the medicine is on pace to top $21 billion in total sales in 2022. That is approximately 35.5% of the $59.1 billion in total revenue that analysts expect from the company in 2022. Unsurprisingly, Merck is doing its best to push its 2028 patent expiration for the drug back as much as possible. The company is currently developing a new formulation that would have its immunotherapy injected under the skin, or “subcutaneously.” This could somewhat protect Keytruda’s revenue from biosimilar competition until at least 2040.
But even if the company isn’t able to buy itself more time to prepare for competition on its marquee drug, it has plenty of other projects in the pipeline to grow over the long haul. Merck currently has 112 programs in late-stage clinical trials, with the overwhelming majority being non-Keytruda oncology, vaccines, and cardiovascular clinical trials. This should more than offset any decline in Keytruda revenue in the future.
In the meantime, analysts forecast that the drugmaker will generate 11.9% annual non-GAAP (adjusted) diluted earnings per share (EPS) growth through the next five years. Putting this into perspective, the rate is well above the drug manufacturer industry average of 6.8%.
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Merck has an attractive and growing dividend
Merck’s 2.7% dividend yield is slightly higher than the average 2.5% dividend yield of the Dow Jones. And income investors will be pleased to learn that they also don’t have to skimp on future dividend growth with the pharmaceutical company. That’s because Merck’s dividend payout ratio will clock in at 37.3% for 2022. This allows the company to retain a significant majority of its earnings to bolster its product portfolio and pipeline via acquisitions. This manageable payout ratio is why I believe that dividend growth will be around 6% annually in the long term.
Merck’s valuation multiple is still cheap
Merck’s wide outperformance of the Dow Jones in 2022 may lead investors to believe that it doesn’t have any room to rally further in 2023. But based on the stock’s valuation, more upside could be ahead.
Merck’s forward price-to-earnings (P/E) ratio of 14.7 is slightly below the drug manufacturer industry average forward P/E ratio of 15.2. The company likely won’t command a sizable premium until it proves that it can successfully navigate the looming Keytruda patent expiration. But it arguably does deserve some sort of premium to its peers by virtue of its superior earnings growth prospects. This could lead to more moderated stock price growth in 2023 compared to 2022, which makes the stock a buy for income investors.