Friday, October 17, 2008
(Cont'd from above)...

We go to the textbook... you know the textbook... Sir Mix-A-Lot... who's second corollary... "I like big yields and I cannot lie"... is the one thing that can protect your capital for better times...

On Wednesday, the 22nd... Merck (MRK)... that's right, the big drug company... MRK... reports its 3rd quarter. Because of the vicious selloffs... just endless selloffs... MRK now yields 5.3%.

It's a drug company, so its earnings won't be threatened by the severe recession that we're calling for here. In short, MRK is your template... a company with a great dividend, and a history of maintaining or increasing it, that's also recession-proof.

So let's say you want to buy 100 shares of MRK... I think that's a good thing to do. I would buy 50 ahead of the quarter, because MRK already yields over 5%... way, way better than treasuries, and that's without even accounting for the tax-favored treatment of dividend income...

How about the next 50?...

As we have emphasized all week, we want to use a scale, based on the yield because, in this market, dividends, and not price-to-earnings multiples, are the most-trustworthy way to value stocks.

So let's say, if MRK hits $27.60 - about a dollar and change below the close - perhaps it goes down because of the quarter... It should take a lot to drive the stock up after it reports, and not that much to drive it down, just because it's such a tough market... but, even though we know it can deliver in this environment...

At that price, MRK yields 5.5%, and that's where you buy the next 25 shares...

When the stock comes down... notice, I'm saying "when" because I'm trying to be as cautious and negative as possible... When it comes down to $25.33, it will yield 6%, and that's where you buy the final 25.

If it doesn't get there... if it goes up... that's the least of your problems. I do not think it will go below $25, so I'm sticking with that Game Plan...

It may not have the highest yield in big pharma...

Eli Lilly & Co. (LLY) yields 5.8%, Pfizer (PFE) yields a whopping 7.6%... (bear sound)... my feeling on PFE... but it has the best cash position. MRK's net cash of $5.6 billion is double the size of PFE's... remember, we're being conservative... and more than triple the size of LLY's cash hoard...

MRK should grow its earnings by 6% next year... I know, not the old double-digit days, when they first had their cholesterol drugs... but, you know what... that's still respectable... compared to PFE, with 3% growth. It leaves that one in the dust. Although LLY is on track to beat them both, growing earnings at 8% next year.

But, when you look core value of the company... that's cash on hand, plus the value of its existing drugs... minus an industry discount... it's a little complicated, but can boil it down... MRK's stripped-down value is worth $29.90... a dollar above here... about where, let's say, PFE's stripped-down value is $14.90 a share. That's two and a half points lower than its current share price... and LLY's stripped-down is 3 points lower than its current share price...

Put simply, MRK's yield may not be as great as PFE or LLY... it may trail LLY when it comes to growth... but, on this important metric, which is a conservative metric, it's much cheaper than either company.

Plus, when it comes to its dividend, MRK's definitely one of the most faithful, and investor-friendly, companies on earth.

Even in 2004... everything went wrong for MRK in 2004... when Vioxx was taken off the market... and three credit rating agencies simultaneously downgraded MRK's debt... it didn't cut its dividend. In fact, it raised it.

Alright, 2008... admittedly not MRK's year... its cholesterol drugs, Vytorin and Zetia have been dogged by questions of efficacy and safety... Gardisil, its HPV and cervical cancer vaccine... Well, it's seen softer sales, due to safety concerns... And the FDA kicked back MRK's application to expand the drug's application to adult women.

MRK may be forced by the FDA to modify the label on its asthma drug, Singulair, for increased risk, with competing over-the-counter allergy drugs eating into sales...

Plus, MRK discontinued the development of two drugs. It had three drugs deferred by the FDA... endless horror for MRK...

and the last time MRK reported, management reduced individual drug sales guidance by 5%, to 27%, for the second half of the year... and pulled its full-year earnings guidance.

In other words, you've got the parade of horribles built in here...

This stock is now priced for total imperfection...

But I think investors will now flock to it as a safe haven to the coming recession... a company that can still grow despite the heinous economy...

In 2005, MRK's brand-new CEO, Dick Clark... he unveiled a five-year plan... to streamline every element of MRK's business...

From 2006 to 2010, the cumulative tax savings from this plan should come in between $4.5 and $5.0 billion... Boy, these drug companies have got a lot of fat, don't they?...

Well, now we're well past the mid-point of the plan, and MRK's exactly where it was before the plan was announced, thanks in part to the brutal declines we've seen lately... MRK still trades on the S&P 500... even though it's a leaner, meaner cash machine, with cash flows expected to increase 11%, to 15%, from last year's levels.

That's not bad. The play is simple...

Look, we're headed into a horrific slowdown. In fact, we may already be there. And we know MRK, with its juicy yield, will deliver.

Does that mean the stock will go up, when it reports, on Wednesday? Even if MRK meets the third quarter consensus, I'm not even sure... but that's not a bad thing. The lower MRK goes, the higher its yield gets, and the more attractive its stock will become.

MRK beat the Street's estimates the last two quarters, and it still sold off... So this quarter could be a real buying opportunity...

Remember, only put a half on ahead (of the Wednesday earnings report), okay...

The company has its issues, but we know the worldwide economic slowdown isn't one of them, and that counts for a lot...

So what would it take for Merck (MRK) to go higher on its earnings report?...

I think the company would have to reinstate its full-year guidance, announce a fat share buyback program, raise the dividend, or report that sales for key products were less weak than expected.

But, you know, even if MRK disappoints, I think people look at this as the last really bad quarter... so the stock could come back, even if it sells off on the news.

Most importantly, you will then get paid to wait (i.e., via the dividend) for a turnaround.

Now, you should also know that MRK's having its annual investor day in early December. This is an analyst lovefest... More importantly, this is where all the medical analysts get to drool over the elegant presentation of MRK's R&D pipeline... and I think it's going to be great. I think it's going to be a positive catalyst for the stock...

It's why I want you to get in 100 shares before that, but not until the stock drops...

Here's the bottom line...

The bottom line!:   Merck (MRK) is the template... a high-yielder that's truly recession-proof... The Game Plan for next week is to buy half ahead of earnings, and then MRK come down to where it yields 5.5%, and then 6%, before you buy more. The Game Plan for the weeks after is to find more stocks that look a lot like MRK.

Read Jim's next Segment here