If you were to only ever own two healthcare stocks under the condition you’d have to hold them for fifty years I’d wager a significant proportion of people would place Abbott Labs stock as second pick after Johnson & Johnson. It’s one of those small number of blue chip stocks that have come to be defined almost exclusively by the stability of their earnings and excellent dividend history.
Speaking of which, the quarterly dividend is basically engrained in their corporate culture. In every single quarter since 1924 Abbott Laboratories have paid a dividend. That’s 324 consecutive pay-outs to holders. The last time they didn’t raise their annual distribution? 1972. Nixon beat McGovern for the White House and US involvement in the Vietnam War was slowly winding down. That sums up the stability of their underlying earnings in a nutshell – they march on through economic conditions of all kinds; steadily growing their distributions year in, year out.
Let’s take a brief look at the last twenty years of Abbott Labs dividends. In 1996 the company declared a total of $0.48 per-share in split adjusted dividends. By 2011, the year before they spun off the pharmaceutical division as AbbVie, that distribution had grown to $1.92. In effect you got to enjoy a compounded pay-rise of 9.7% a year while the business hummed along nicely in the background. During arguably the worst economic crisis since the Great Depression the company managed to post earnings per-share of $2.31 in 2007, $3.12 in 2008 and $3.69 in 2009. It breezed through – with healthcare in general being fairly immune to economic conditions.
Those are the kinds of figures that give you clarity in the years when the stock price doesn’t do anything at all. Look at the chart between 1999 and 2011 for example. On the face of it you get the same calls of dead money that hit pretty much all the healthcare stocks over that period; that’s what happens where you have two or three years at the start of the period in which the average annual P/E ratio is around 25x earnings. The valuation multiple contracts for whatever reason and then ends up kind of cancelling out the positive effects of earnings growth in the underlying business.
But here’s the thing – that burn-off period inevitably sets up the next leg of returns. Even though the company powered through the global financial crisis by growing its earnings by 17% a year the share price wasn’t responding. Investors ended up in a situation where Abbott stock was going for between 10-13x earnings whilst chucking off an average dividend yield of about 3.5%. How many investors would’ve either deserted the stock long before that point or decided that Abbott’s short term history wasn’t exciting enough to merit an investment? I’d hazard a guess that a lot were in that position.
Johnson & Johnson stock had exactly the same issue between 2002 and 2012: for a whole decade the shares would’ve given you pretty much nothing by way of capital gains. All because folks were paying between 25-30x earnings in the early 2000s. Meanwhile the underlying business did well. Earnings-per-share grew from $2.23 in 2002 to $5.00 in 2012. Likewise with the annual dividend – which increased at an average compounded rate of 12.2% a year. By 2012 the stock was going for around 13x earnings along with a 3.6% dividend yield.
When you look at these two cases over the entire time-frame in question the returns end up looking respectable despite the fact that the earnings multiple has contracted from the highs of the late-1990s/early-2000s. I’d say 5% of real, above inflation returns per-year fits that definition all things considered. Imagine the returns on a regular investment program where you smooth out the effect of investing in periods of high valuation. Or being able to allocate fresh capital to either stock in the period of 2009-2011. You then find yourself in the realm of quite serious wealth-creation.
That’s the deal with a stock like Abbott Labs; it needs to be looked at over a long-term horizon to see the full picture. Remember this is a stock that managed to deliver annual returns of 16.5% a year between 1957 and 2003. The only stock from the original S&P 500 to outperform over that period was Philip Morris.
You get the impression from reading comments on financial media articles about these kind of stocks that they are to be traded out for something new at the first sign of some stagnation. That’s a poor approach to adopt because it generally means that they end up discarding the stocks at precisely the moments when they are becoming significantly undervalued.
According to the figures in front of me analysts are pegging Abbott to make $2.20 in earnings-per-share for this financial year. On a current share price of $41 that puts the stock at about 18.5x forward earnings, which is probably in the mid-to-high range of the recent historical valuations. Factor in that the company generate most of their revenues from abroad and the accounting figures arguably paint a worse picture than what’s actually going on in reality. Where does that put the stock? Probably slap-bang in the middle of the fair value range. And for a high quality company like Abbott Labs that has historically proven to be conducive to a healthy rate of long-term returns.