As far as large-cap pharmaceutical plays go, Merck (NYSE:MRK) has been a good pick. MRK stock has outperformed fellow giant Pfizer (NYSE:PFE), returning (including dividends) 62% over the past five years and 249% over the last ten.
But that qualifier — “as far as large-cap pharmaceutical plays go” — is a big one. The pharmaceutical space in general hasn’t been much of a winner for investors. The iShares U.S. Pharmaceuticals ETF (NYSEARCA:IHE) has provided negative total returns over the past five years. That’s with help from the likes of Merck and Johnson & Johnson (NYSE:JNJ), the two biggest holdings.
To be sure, big returns aren’t necessarily the major reason to own large-cap pharmaceutical names. Historically, investors have looked to the sector for defensive performance, some growth and dividends. MRK stock admittedly still has those attributes.
But even that backward-looking case has some question marks. Meanwhile, there are more exciting, more attractive investments elsewhere in the industry. Large-cap pharma investing isn’t necessarily dead, but it certainly seems like investors can do better than the sector, and Merck.
The Case for Large-Cap Pharma
The case for diversified pharmaceutical companies like Merck long has been based on the defensive nature of the business. The downside in MRK stock should be protected in two ways.
First, the business generally isn’t that sensitive to the broader economy. To be sure, certain drugs for non-essential conditions may take a hit if unemployment rises (which in the U.S. means fewer patients on insurance) or consumer spending slows. But, overall, important drugs that are on patent generally hold up.
Indeed, Merck’s revenue only dipped modestly in 2008, as the world headed into the financial crisis. Sales increased the following year, even excluding a boost from the company’s merger with Schering-Plough. Merck got back to growth in 2011, and maintained its dividend throughout the crisis.
The second defensive aspect of the business is the drug portfolio itself. The failure of a single drug doesn’t necessarily ruin the stock. That’s even true for Merck’s verubecestat, an Alzheimer’s treatment that failed Phase III trials back in 2018.
At the moment, Merck admittedly is a little top-heavy. Blockbuster cancer treatment Keytruda drove almost one-quarter of sales in 2019, according to a filing with the U.S. Securities and Exchange Commission. The top ten drugs in total drive two-thirds of revenue.
But a giant company like Merck can manage declines in some products, while using a massive research and development budget (almost $10 billion in 2019) to create new sources of growth. Barring a series of flops, the business should hold up in almost any conditions.
The Concerns with MRK Stock
But as the performance of the sector exchange-traded fund shows, that strategy isn’t necessarily working all that well of late. MRK stock admittedly has been an exception, but that’s because it developed Keytruda. Excluding that drug, revenue has declined 1.5% over the past two years.
And it’s not guaranteed that another Keytruda is on the way. Pfizer is a good example. Its stock has barely moved over the past five years, and still trades below 2001 levels.
It’s important to remember that investing is about trade-offs. And in buying a diversified operator like Merck, investors are giving up the potential for explosive growth. For some investors, that’s the right call. But I also worry whether drug development, particularly for diversified majors, is quite as safe as investors long have believed.
Notably, political pressure on drug prices is rising worldwide. In the U.S., Democrats long have criticized “Big Pharma.” President Trump, meanwhile, called for a bipartisan deal to lower prices during his State of the Union speech this year.
It’s easy to look at Merck and assume that it’s a safe source of returns. The stock has performed well in recent years, though not quite as well as somewhat smaller rivals Bristol-Myers Squibb (NYSE:BMY) and Eli Lilly (NYSE:LLY). A 3% dividend yield is attractive at a time when 10-year Treasuries are yielding less than 1%.
But there are risks here, even if the most likely risk is simply MRK stock being “dead money” for the next few years.
For the right kind of investor, MRK stock probably is a solid choice. It’s no doubt a safer play. Income investors definitely should take a long look.
But more aggressive investors should look elsewhere. Smaller pharmas and, in particular, biotech names look attractive. I’ve recommended Gilead Sciences (NASDAQ:GILD) multiple times, and still like it as its coronavirus treatment shows promise.
Smaller companies, and in particular single-product, zero-revenue biotech plays, obviously offer dramatically more risk. But investors can mitigate that risk through a basket strategy — or an ETF. The iShares NASDAQ Biotechnology ETF (NASDAQ:IBB) has dramatically outperformed IHE in recent years. I’d expect it to do so going forward as well.
There simply are bigger potential returns elsewhere in the industry than those offered by MRK stock. Admittedly, for some investors, that’s a problem, because those returns entail more risk. But for investors who are staying aggressive, who are betting on innovation and who are looking for real winners, MRK stock simply is not the right choice.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. The power of being “first” gave Matt’s readers the chance to bank +2,438% in Stamps.com (STMP), +1,523% in Ulta Beauty (ULTA) and +1,044% in Tesla (TSLA), just to name a few. Click here to see what Matt has up his sleeve now. Matt does not directly own the aforementioned securities.