Please ensure Javascript is enabled for purposes of website accessibility

Abbott Labs: Too Cheap to Ignore?

By Dan Carroll - Apr 8, 2013 at 10:01AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Here's a classic case of how relying on the P/E ratio can deceive investors.

Looking for a cheap stock with name-brand power and a strong, diversified portfolio of products? At first glance, you couldn't do much better than Abbott Labs (ABT 1.58%). The company's stock has jumped more than 5.4% year-to-date since its spinoff of former pharmaceutical business AbbVie (ABBV -0.38%), yet it's still trading at a price-to-earnings ratio of just over 9.8.

Impressed? Buyer beware: This is a textbook example of why the P/E ratio, one of the fundamental numbers for valuing stocks, isn't always an investor's best friend. For all its strengths and potential, Abbott's not as cheap as it looks.

As cheap as it looks?
Comparing Abbott's P/E to other major diversified health care firms would make many investors think it an extraordinarily cheap stock. Johnson & Johnson (JNJ 0.91%) by comparison sports a much higher P/E of 21.3, while Merck's (MRK 0.83%) is even higher, at 22.7. Abbott's stock has outperformed Merck over the past year, and its 23% growth compares well with J&J's. But is Abbott so cheap after all?

This is a case where it's important to read the fine print. Price-to-earnings ratios involve earnings over the trailing 12 months. Guess what Abbott still had over its last reported 12 months? If you guessed AbbVie -- its pharmaceuticals division and now-independent company that made up the biggest single division by sales and a huge chunk of earnings last year -- you're right.

AbbVie reported net earnings for the past year of $5.2 billion – earnings actually earned by Abbott, which saw full-year 2012 earnings of around $6 billion in all. Take away that $5.2 billion and Abbott's P/E grows substantially. To get a better idea of the new Abbott's real valuation, take a look at its forward P/E, based upon analyst projections of future earnings over the next fiscal year. Abbott's forward P/E of 15 makes it a good deal more expensive than Johnson & Johnson's forward P/E of 13.8 or Merck's considerably smaller ratio of 11.5.

Cheap? Perhaps not after you consider Abbott's downsizing. But that doesn't mean this is a stock you should avoid; on the contrary, Abbott has plenty of growth opportunities ahead despite shedding its blockbuster-fueled branded pharmaceuticals business.

Reasons for faith
The branded pharmaceuticals business is notable for its high margins and boom-or-bust risks. Losing that business doesn't lend itself to cheap P/E valuations for Abbott's future, with divisions such as nutritionals and generic drugs fueling tomorrow's revenue. Still, this company didn't make a shortsighted move by spinning off AbbVie.

On the contrary, Abbott refocused into a leaner, more stable firm that will keep on rewarding investors for some time to come. Shedding its pharmaceutical business freed Abbott from the patent-cliff-related headaches affecting rivals such as Merck, which has struggled to recapture revenue lost from blockbuster drug Singulair's patent expiration. While spinoff AbbVie will have to deal with the loss of massive blockbuster drug Humira's patent protection in the near future, Abbott can look forward to a stable, if slower-growing, future.

Nonetheless, if Abbott interests you, don't judge the stock by its P/E valuation. There are plenty of reasons to have faith in this company's future, from its emerging market growth in areas such as nutritionals to its dominant position in the drug-eluting stent market. Buying it just because it looks cheap at first glance, however, is a move that will leave investors disappointed.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Abbott Laboratories Stock Quote
Abbott Laboratories
ABT
$116.69 (1.58%) $1.82
Merck & Co., Inc. Stock Quote
Merck & Co., Inc.
MRK
$93.08 (0.83%) $0.77
Johnson & Johnson Stock Quote
Johnson & Johnson
JNJ
$181.09 (0.91%) $1.63
AbbVie Inc. Stock Quote
AbbVie Inc.
ABBV
$150.00 (-0.38%) $0.57

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
356%
 
S&P 500 Returns
124%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/28/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.