After completing a $5 billion buyback program started late 2008, Abbott Labs (NYSE:ABT) is ready to buy another $3 billion worth of Abbott Laboratories stock.
Abbott Laboratories seems to think its stock is cheap enough to justify sinking a substantial amount of its nest egg into the company's stock. At the end of the first quarter, Abbott had about $8.5 billion in cash and short-term investments.
Of course, just because the board has authorized the buyback doesn't mean that management has to buy shares. And the company didn't give a time frame for when the buyback program would be complete. Considering that it took almost five years for Abbott to work through the last $5 billion, I'd expect that this $3 billion authorization could take three years, perhaps more since it's a smaller company now.
That gives the company a little time to earn some or all of the cash for the buyback; Abbott is projecting $4 billion in cash flow this year. It'll have to pay capital expenses out of that and pay the dividend, which is expected to make up between 25% and 30% on a cash basis. But that should still leave cash to pad the coffers and use for the buyback of Abbott Laboratories stock.
A whole new company
The new Abbott has different capital requirements after spinning off its pharmaceutical division, AbbVie (NYSE:ABBV). The company now has four divisions: nutrition, diagnostics, established pharmaceuticals -- a euphemism for old drugs that it can sell overseas where branded-generics are common -- and medical devices.
Without the drugs, I think there's less of a need to hunt for high-risk, high-reward acquisitions. Abbott will almost certainly make some acquisitions to fill in each of its divisions, but investors shouldn't be looking for the company to make acquisitions like AbbVie needs to make to move the needle substantially and make up for patent expirations.
AbbVie's top drug, Humira, for instance, was acquired when Abbott/AbbVie acquired the pharmaceutical arm of BASF for $6.9 billion when the drug was still code named D2E7. The acquisition has clearly paid off many times over.
All the cool kids are doing it
Abbott isn't the only large health care company trying to increase earnings per share by reducing share count through buybacks. Merck (NYSE:MRK) recently announced plans to accelerate the purchase of $5 billion worth of Merck stock as part of a $15 billion repurchase. After Pfizer (NYSE:PFE) sold its nutrition business, it pledged to use the cash in a $10 billion repurchase.
Repurchasing shares has a two-fold effect on the company's valuation. It increases the earnings per share because there are fewer shares outstanding, and the company has to make a lower aggregate dividend payment since there are fewer shares due the dividend.
We can debate whether a higher dividend would be a better choice for Abbott than repurchasing Abbott Laboratories stock, especially since management at Merck, Pfizer. and the rest of Abbott's peers haven't exactly been best at market timing their repurchases.
But however the company chooses to get the cash back to investors is a better choice than sitting on the cash or making frivolous purchases.
Fool contributor Brian Orelli has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.