Merck & Co., Inc.'s (NYSE:MRK) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Unlock stock picks and a broker-level newsfeed that powers Wall Street. Upgrade Now

editorial-team@simplywallst.com (Simply Wall St)

Wed, Jan 29, 2025, 5:00 AM 4 min read

With its stock down 7.0% over the past three months, it is easy to disregard Merck (NYSE:MRK). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Merck's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Merck

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Merck is:

27% = US$12b ÷ US$45b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.27 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Merck's Earnings Growth And 27% ROE

Firstly, we acknowledge that Merck has a significantly high ROE. Secondly, even when compared to the industry average of 19% the company's ROE is quite impressive. Yet, Merck has posted measly growth of 2.1% over the past five years. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or or poor allocation of capital.

As a next step, we compared Merck's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 1.2%.

past-earnings-growth — NYSE:MRK Past Earnings Growth January 29th 2025

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Merck fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Merck Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 55% (that is, the company retains only 45% of its income) over the past three years for Merck suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

Additionally, Merck has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 33% over the next three years. The fact that the company's ROE is expected to rise to 35% over the same period is explained by the drop in the payout ratio.

Summary

On the whole, we feel that Merck's performance has been quite good. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.