Is It Time To Sell Merck & Co Inc (NYSE:MRK) Based Off Its PE Ratio?
I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in Merck & Co Inc (NYSE:MRK).
Merck & Co Inc (NYSE:MRK) is currently trading at a trailing P/E of 105x, which is higher than the industry average of 24.2x. While this makes MRK appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Merck
What you need to know about the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for MRK
Price-Earnings Ratio = Price per share ÷ Earnings per share
MRK Price-Earnings Ratio = $61.03 ÷ $0.581 = 105x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to MRK, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since MRK’s P/E of 105x is higher than its industry peers (24.2x), it means that investors are paying more than they should for each dollar of MRK’s earnings. Therefore, according to this analysis, MRK is an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that MRK should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to MRK, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with MRK, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing MRK to are fairly valued by the market. If this is violated, MRK’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on MRK, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for MRK’s future growth? Take a look at our free research report of analyst consensus for MRK’s outlook.
Past Track Record: Has MRK been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of MRK’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
