There wouldn't be many who think Merck & Co., Inc.'s (NYSE:MRK) price-to-earnings (or "P/E") ratio of 20.2x is worth a mention when the median P/E in the United States is similar at about 18x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.
Merck certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. One possibility is that the P/E is moderate because investors think the company's earnings will be less resilient moving forward. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.
Check out our latest analysis for Merck
Does Growth Match The P/E?
There's an inherent assumption that a company should be matching the market for P/E ratios like Merck's to be considered reasonable.
Retrospectively, the last year delivered an exceptional 342% gain to the company's bottom line. The latest three year period has also seen an excellent 274% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Turning to the outlook, the next three years should generate growth of 23% per annum as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 10% each year, which is noticeably less attractive.
With this information, we find it interesting that Merck is trading at a fairly similar P/E to the market. It may be that most investors aren't convinced the company can achieve future growth expectations.
The Key Takeaway
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
Our examination of Merck's analyst forecasts revealed that its superior earnings outlook isn't contributing to its P/E as much as we would have predicted. There could be some unobserved threats to earnings preventing the P/E ratio from matching the positive outlook. At least the risk of a price drop looks to be subdued, but investors seem to think future earnings could see some volatility.
Having said that, be aware Merck is showing 1 warning sign in our investment analysis, you should know about.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
About NYSE:MRK
Very undervalued with solid track record and pays a dividend.
