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Better Growth Play: Merck or The Vanguard Growth Index Fund?

Motley Fool - Mon Apr 15, 8:00AM CDT

The pharmaceutical industry is currently grappling with a major investment problem. Since 2004, the shares of most major pharmaceutical companies have been lagging behind the S&P 500. A few exceptions to this trend do exist. Eli Lilly and Novo Nordisk, for example, have benefited from the breakout commercial success of their new weight loss drugs, causing their share prices to soar.

Still, the overall performance of big pharma stocks over the past two decades can only be described as lackluster. The primary reason for this underperformance is the increasing risk associated with the big pharma business model.

A hand arranging wooden blocks in a pattern indicating growth.

Image Source: Getty Images.

Major drug manufacturers aim to develop a few blockbuster medicines every decade to offset aging patent portfolios. However, the allure of this strategy has diminished through increased competition, a challenging regulatory environment, and a dynamic reimbursement landscape that doesn't always properly reward companies for developing risky new therapies.

A trend breaker

Merck(NYSE: MRK), a leading U.S. drug manufacturer, has defied this industrywide trend in 2024. Merck's shares have seen a nearly 16% increase this year, outperforming the benchmark S&P 500, which has gained 7.8% during the same period.

This leads us to an intriguing question: Is Merck's red-hot stock a better growth play than the popular Vanguard Growth Index Fund(NYSEMKT: VUG)? Let's compare these two top growth vehicles to find out.

Merck vs. the Vanguard Growth Index Fund

Currently, Merck's shares are trading at a forward earnings multiple of 14.7, which is a bargain when compared with the average forward price-to-earnings ratio of 17 for its big pharma peers.

Merck also offers a respectable annualized dividend yield of 2.44%, which stands out when compared to the average yield of 1.35% among the constituents of the S&P 500. However, compared to peers like Pfizer, Bristol Myers Squibb, and Gilead Sciences, who all offer yields above the 4% mark, Merck's dividend yield seems relatively modest.

According to Wall Street's consensus estimate, Merck's earnings are expected to grow by 14% in 2025, primarily driven by its blockbuster cancer drug, Keytruda. However, it's crucial to note that Merck is set to lose market exclusivity for Keytruda in 2028, which poses a significant risk to the stock.

On the flip side, the Vanguard Growth Index Fund (VUG) trades at a premium valuation, over 37 times earnings. This hefty valuation is supported by its supercharged average earnings growth rate of 19.5% and its high-profile holdings in artificial intelligence (AI), innovative weight loss therapies, and advanced software platforms.

In addition, the VUG offers a modest yield of approximately 0.53% and an ultra-low expense ratio of 0.04%. While the fund's portfolio is somewhat diversified across most major sectors of the economy, 55.7% of its holdings consist exclusively of technology stocks.

The verdict

Deciding between investing in Merck's stock and the VUG is not as simple as it may seem. While Merck's higher yield and appealing valuation are hard to ignore, the diversification offered by VUG presents a significant advantage that makes it attractive to investors.

VUG's extensive portfolio shields it from the concentrated risks that single stocks often face. For instance, a major revenue-generating patent expiring can pose a significant threat to a company like Merck. This is a hurdle that Merck will have to overcome shortly, and it could potentially put downward pressure on its stock price for an extended period.

Considering VUG's lower risk profile and its exposure to powerful trends such as AI, it stands out as a more enticing option for long-term growth than Merck. Thus, while both investment avenues have their strengths, the VUG appears to be the more promising growth prospect in this comparison.

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George Budwell has positions in Pfizer. The Motley Fool has positions in and recommends Bristol Myers Squibb, Gilead Sciences, Merck, Pfizer, and Vanguard Index Funds-Vanguard Growth ETF. The Motley Fool recommends Novo Nordisk. The Motley Fool has a disclosure policy.

Paid Post: Content produced by Motley Fool. The Globe and Mail was not involved, and material was not reviewed prior to publication.

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