Let's cut to the chase: Yes, AbbVie Inc. (ABBV -0.73%) stock is a great pick for long-term investors, in my view. The reason why I think the big pharma stock is one to buy is simple: There's a good chance that it will deliver market-beating returns for years to come.
By market-beating returns, I mean a total return of more than 9% to 10% annually on average. That's what the S&P 500 has delivered since 1965. Can AbbVie generate an even higher total return over the long run? I think it can -- because of three key factors.
1. A fantastic dividend
AbbVie automatically has a head start on topping a 10% average annualized return thanks to its fantastic dividend. The company's dividend currently yields nearly 4%. By comparison, the S&P 500 index's dividend yield is less than 2%.
Of course, just because AbbVie's dividend looks great now doesn't mean that it always will. We can have a pretty good level of confidence with AbbVie, though, for a couple of reasons.
First, the big pharma company definitely has the financial flexibility to keep the dividends flowing at current levels for a long time to come. AbbVie uses only 42% of its free cash flow to fund the dividend program. Its financial condition would have to deteriorate a lot before the dividend would be threatened. The good news is that AbbVie's free cash flow isn't worsening and is instead getting even stronger.
Second, AbbVie's management team prioritizes the dividend very highly. That's evidenced by the fact that AbbVie's dividend has increased by 140% since the company was spun off from Abbott Labs in 2013. Remember also that most of AbbVie's current executive team came from Abbott, which has paid quarterly dividends since 1924 and has increased its dividend payout for 46 consecutive years.
2. Strong earnings growth
A great dividend isn't enough to beat the S&P 500's total return, though. AbbVie needs to be able to also generate strong earnings growth. Wall Street analysts think the company will be able to grow earnings by more than 17% annually over the next few years. That seems attainable, in my view.
The company historically has relied on Humira for most of its growth. That's changing, however, with several other products that are either already on the market or are on the way. Imbruvica serves as the cornerstone of AbbVie's growth strategy. It's projected to become the No. 4 selling cancer drug in the world by 2022, with sales of $7.5 billion.
Another cancer drug in AbbVie's lineup, Venclexta, should benefit tremendously from expanded indications in treating relapsed or refractory and first-line chronic lymphocytic leukemia (CLL), acute myeloid leukemia (AML), and multiple myeloma. Venclexta gained FDA approval in 2016 for treating CLL with 17p deletion. Peak sales for the drug could be as high as $3 billion.
AbbVie's hepatitis C drug, Mavyret, was the star of the company's Q1 update. Market research firm EvaluatePharma projects the drug will reach peak annual sales of $1.9 billion by 2021.
Then there's AbbVie's pipeline, which features three especially promising candidates. AbbVie anticipates FDA approval for elagolix in treating endometriosis in the third quarter of 2018. The company also hopes to launch two new autoimmune disease drugs in 2019: risankizumab and upadacitinib. All three drugs are expected to be blockbusters.
3. Attractive valuation
Earnings growth in the upper teens probably wouldn't be enough to drive AbbVie stock higher faster than the market if its share price was already expensive. That's not the case for AbbVie, though.
The pharma stock currently trades at 11 times expected earnings. Considering AbbVie's realistic growth prospects, the stock could even be considered to be a bargain.
What could get in the way
There are two key things that I think could get in the way of AbbVie delivering a market-beating total return. One is if Humira sales deteriorate much more quickly than expected in the face of biosimilar competition. Biosimilars to Humira hit the market in Europe later this year and in the U.S. in early 2023. The other potential challenge is the risk of major pipeline setbacks.
I'm not too concerned about the first threat. AbbVie CFO Bill Chase stated in March that "you're not going to see anything catastrophic" happen with Humira sales despite biosimilar competition. Based on the experience of other big drugs that now compete with biosimilar rivals, I suspect that Chase is right. Sales for Humira will no doubt decline, but I expect that decline to be gradual.
We can't dismiss the possibility that AbbVie will encounter some significant pipeline setbacks, though. The company already experienced one with the disappointing phase 2 results for Rova-T as a third-line treatment for relapsed/refractory small cell lung cancer (SCLC). However, AbbVie's other late-stage pipeline candidates don't carry the same level of risk that Rova-T did, in my opinion.
While there's always a chance that AbbVie will underperform the S&P 500 in the coming years, I think the odds are definitely in favor of AbbVie beating the market. I have owned the stock for a while and don't plan on selling it anytime soon.