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Better Buy: Johnson & Johnson vs. Merck

Keith Speights, The Motley Fool

This big pharma claims one of the hottest cancer drugs around. But it also faces challenges for some of its biggest-selling drugs. Which big pharma is it?

Actually, it's two: Johnson & Johnson (NYSE: JNJ) and Merck (NYSE: MRK)

These companies are similar in several ways. However, Johnson & Johnson stock is up big in 2017, while Merck stock has lost ground this year. Will J&J continue to be the better pick, or will Merck roar back? Here's how these pharma stocks compare.

Two scientists side by side in lab

Image source: Getty Images.

Growth

The consensus among Wall Street analysts is that Johnson & Johnson will grow annual earnings by 7% over the next five years. Analysts project that Merck's annual earnings growth will be less than 5%. Both companies have good and bad news that will impact earnings over the next several years.

For Johnson & Johnson, the good news primarily comes from its pharmaceutical segment. Sales for blockbuster psoriasis and psoriatic arthritis drug Stelara continue to grow significantly. J&J is seeing even stronger growth from two of its cancer drugs, Imbruvica and Darzalex. 

Acquisitions have also helped fuel growth for a couple of its business segments. Johnson & Johnson's acquisition earlier this year of Swiss drugmaker Actelion gave the company a solid pulmonary hypertension franchise. The purchase of Abbott Medical Optics in the first quarter of 2017 boosted sales for J&J's medical device segment. 

Johnson & Johnson also claims a promising drug pipeline, with market research firm EvaluatePharma ranking the company's pipeline No. 5 in the biopharmaceutical industry. One candidate with especially tremendous prospects is prostate cancer drug apalutamide. J&J hopes to win FDA approval for the drug in 2018. 

On the other hand, Johnson & Johnson's top-selling drug Remicade now has biosimilar competition. Although J&J has used multiple tactics to reduce the amount of market share lost, sales for Remicade have still fallen by 9% in the first nine months of 2017 compared to the prior-year period. Other drugs have also lost steam, including type 2 diabetes drug Invokana and chemotherapy Velcade.

Merck's growth now and over the next few years will stem largely from Keytruda. EvaluatePharma projects that Keytruda will become the third-biggest-selling cancer drug in the world by 2022, with annual revenue of $9.5 billion. The drug is by far the brightest spot in Merck's current product lineup. 

Animal health is another winner for Merck. High demand for companion animal products and vaccines, along with Merck's acquisition of Brazilian animal health products company Vallee S.A., have propelled revenue higher for the business segment. 

There are several downsides for Merck, though. Sales are falling for several of the company's products. Cardiovascular drugs Zetia and Vytorin lost exclusivity. Respiratory drug Singulair also continues to struggle in the face of generic competition. And the drugmaker's late-stage pipeline prospects outside of Keytruda look iffy, with Alzheimer's disease drug verubecestat already failing in one late-stage clinical study and heart-failure drug vericiguat not meeting its primary endpoint in a phase 2 study. 

Dividend

At first glance, Merck would seem to be a slam-dunk winner when it comes to dividends. The company's dividend currently yields 3.46%. Johnson & Johnson's yield stands at 2.4%.

However, sustainability of the dividend is a different story. Johnson & Johnson has increased its dividend for 55 consecutive years. It currently uses roughly 57% of earnings to fund the dividend, indicating plenty of flexibility to keep that streak alive.

Merck, though, can't claim such an impressive track record of dividend increases. The company's payout ratio of over 180% also gives reason for pause. Merck's dividend payments over the last 12 months have exceeded the free cash flow that the drugmaker generated, a scenario that can't go on indefinitely. 

Valuation

If you only look at forward earnings multiples, Merck has the more attractive valuation. The stock trades at less than 14 times expected earnings, while Johnson & Johnson stock trades at 18 times expected earnings. The tables are turned looking at trailing-12-month price-to-earnings (P/E) ratios, though. J&J's trailing P/E is under 25, while Merck stock trades at a whopping 54 times trailing-12-month earnings.

Better buy

I don't think Merck is a horrible stock. Keytruda is a fantastic asset for the company. And the dividend yield is pretty sweet right now. However, I'm not overly impressed with Merck's pipeline. I wouldn't look for much more growth, if any, in the dividend over the next few years, either.

In my view, Johnson & Johnson is the better buy. It has better growth prospects. The dividend is almost certain to grow. J&J also has greater financial flexibility to make more acquisitions to drive revenue and earnings higher. Johnson & Johnson has been one of the most solid and stable stocks on the market for a long time. I think that will continue to be the case in the future.

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Keith Speights has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Johnson & Johnson. The Motley Fool has a disclosure policy.