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Why You Might Swap Your Merck for Johnson & Johnson

NEW YORK (TheStreet) -- Sometimes when an investor wants exposure to the pharmaceutical and health care sector it's better to buy an exchange-traded fund for the sake of diversity.

Many want to own the best-in-breed or, more specifically, the best-in-the-sector. Yet, what if you're already invested in two of the great ones like Pfizer (PFE) and Merck (MRK)?

Your asset allocation strategy may say it's time to sell one and use that cash to buy the Big Kahuna of drugmakers, over-the-counter remedies, medical products and other related consumer goodies.

I'm referring to Johnson & Johnson (JNJ). With a market cap of more than $246 billion, it's arguably the world's largest health care company.

JNJ has three divisions: pharmaceutical, medical devices, and diagnostics and consumer. Pharmaceutical accounts for 38% of the company's revenue and has been the highlight because of its strong pipeline, especially in oncology and immunology, which helped to drive 12% revenue growth in the second quarter.

Jim Cramer and Stephanie Link at Action Alerts PLUS wrote on Friday, "We see continued strength in these two segments [oncology and immunology], but we also believe the company is well positioned for the long term with pipeline opportunities in treatments for cancer, pain, schizophrenia, hepatitis C and HIV."

They also commented that during the second quarter, immunology sales rose by nearly 17% "... driven by strong Remicade sales of 9.8% and solid results from Simponi and Stelara.

"We expect this strength to continue, given the growth in the overall market, expansion into international markets (emerging markets grew 20% in the second quarter) and share gains."

Investors who acted upon their past preference for Merck did quite well when it came to total returns, which included MRK's dividend. The stock peaked on June 4 at $50.16 and has corrected.

MRK is currently selling at a forward (one-year) PE ratio of slightly less than 13. Its price-to-earnings-growth (PEG) ratio (five-year expected) is an unusually high 5.02 which could signal shares are overvalued.

Presently I'd favor JNJ over MRK for the same reasons Cramer and Link do: "We prefer it [JNJ] to Merck, given its stronger growth and better pipeline, and we like the potential for shareholder value creation, which ultimately led to a spin-out of its consumer segment."

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