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Buying a low-cost index fund will get you the average market return. But if you invest in individual stocks, some are likely to underperform. For example, the Merck & Co., Inc. (NYSE:MRK) share price return of 20% over three years lags the market return in the same period. Zooming in, the stock is actually down 20% in the last year.
While this past week has detracted from the company's three-year return, let's look at the recent trends of the underlying business and see if the gains have been in alignment.
View our latest analysis for Merck
While the efficient markets hypothesis continues to be taught by some, it has been proven that markets are over-reactive dynamic systems, and investors are not always rational. One flawed but reasonable way to assess how sentiment around a company has changed is to compare the earnings per share (EPS) with the share price.
During three years of share price growth, Merck achieved compound earnings per share growth of 27% per year. The average annual share price increase of 6% is actually lower than the EPS growth. So it seems investors have become more cautious about the company, over time.
You can see how EPS has changed over time in the image below (click on the chart to see the exact values).
We know that Merck has improved its bottom line lately, but is it going to grow revenue? If you're interested, you could check this free report showing consensus revenue forecasts.
What About Dividends?
When looking at investment returns, it is important to consider the difference between total shareholder return (TSR) and share price return. The TSR is a return calculation that accounts for the value of cash dividends (assuming that any dividend received was reinvested) and the calculated value of any discounted capital raisings and spin-offs. It's fair to say that the TSR gives a more complete picture for stocks that pay a dividend. We note that for Merck the TSR over the last 3 years was 31%, which is better than the share price return mentioned above. And there's no prize for guessing that the dividend payments largely explain the divergence!
A Different Perspective
Investors in Merck had a tough year, with a total loss of 17% (including dividends), against a market gain of about 27%. Even the share prices of good stocks drop sometimes, but we want to see improvements in the fundamental metrics of a business, before getting too interested. On the bright side, long term shareholders have made money, with a gain of 6% per year over half a decade. It could be that the recent sell-off is an opportunity, so it may be worth checking the fundamental data for signs of a long term growth trend. It's always interesting to track share price performance over the longer term. But to understand Merck better, we need to consider many other factors. For instance, we've identified 2 warning signs for Merck that you should be aware of.