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Merck: Greed beats fear
For now. Plus: Milking Blockbuster for its cash.
December 3, 2003: 4:09 PM EST
By Adam Lashinsky, CNN/Money contributing columnist

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MENLO PARK, Calif. (CNN/Money) - The recent rise in the shares of troubled drug maker Merck is killing me. Here's why.

It's clich, but totally accurate, that precisely two factors drive movements in stocks: fear and greed.

My greed glands got going during the Thanksgiving lull when I read an article about Merck on the front page of the Wall Street Journal. Two sentences, amid a long explanation of Merck's clogged drug-pipeline problems, got me interested in the stock.

"Merck shares are changing hands at around $41, and the company expects to earn just under $3 a share this year, so its price-to-earnings ratio is about 14," the article said. "Other drug makers have much higher ratios -- 29 for Eli Lilly and 22 for Johnson & Johnson, for example."

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That low P/E caught my eye.

Higher-growth companies get higher P/Es, but in my mind Merck's three bucks of earnings are just as good as anyone else's, at least in the short term.

What's more, at $40 Merck's $1.48 annual dividend yielded 3.7 percent, significantly better than my money-market accounts.

I apparently wasn't alone in my enthusiasm.

After dropping on the slow-trading day of the Journal's article to a 52-week low of $40.57, Merck's shares have been up every day this week.

First Merck announced that it had signed a deal with a small drug-discovery company, a move critics said Merck needed to make.

Then, today, Merck announced that its 2004 earnings should rise (investors didn't seem to mind that Merck slightly lowered its earnings guidance).

Investors bid up Merck's shares with the rest of the juiced-up market, to a midday level of $43.70, or about 8 percent above Friday's low.

So was the pessimism about Merck's future correct last week? Or are the value hunters who acted on my instincts on to something? (Alas, I did not act. I don't own shares of Merck.)

Probably both. The company is risky for its stale drug pipeline, but it's an easy value opportunity because of those solid earnings (the P/E now is closer to 15) and its dividend yield, now about 3.4 percent.

For now, greed wins.

Its and Bits, Part I: Viacom's Blockbuster divestiture

There was a nice nugget in Tuesday's Wall Street Journal about Viacom (VIA.B: Research, Estimates) supposedly planning to dump its 80-percent-plus stake in Blockbuster (BBI: Research, Estimates).

The paper explained that a private-equity group might be willing to buy Blockbuster because it generates lots of cash. The private-equity group could use debt to buy Blockbuster at an attractive price, then use the cash flow to pay down the debt.

This little lesson got me thinking about the vicissitudes of leveraged buyouts.

If this formula is so easy -- and the conventional wisdom is that the "smart money" investors who would buy Blockbuster know what they're doing -- why doesn't Blockbuster just do it itself?

Borrow money and announce to shareholders that it will milk the profits of the slow- to no-growth company to pay down the debt. Why are we public investors so obsessed with growth that we can't see a good thing the way the pros do and invest in it?

Anybody care to argue about, ahem, I mean, discuss this?

Its and Bits, Part II: Suggested reading on California politics

Following the various circuses in California these days -- the new Schwarzenegger administration and the San Francisco mayoral race being the two best examples -- isn't for everyone.

Should these spectacles pique your interest, however, I highly recommend an eclectic blog written by a former colleague and current friend of mine, Chris Nolan, one of the best damn reporters west of the Mississippi.

The blog, at www.chrisnolan.com, is a highly entertaining, exceedingly witty combination of scathing critiques, helpful instruction and links to a wide variety of news and feature articles about political goings-on in the Golden State. Check it out.


Adam Lashinsky is a senior writer for Fortune magazine. Send e-mail to Adam at lashinskysbottomline@yahoo.com.

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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.