Capital Investment Analysis: Abbott Laboratories Project

Abbott Laboratories is a prime prospect for capital investment based on its projected ability to deliver current goals and compatibility, having overall risk level tolerance within the scope of this project. Apart from being a publicly traded company in the S&P 500, Abbott Laboratories is a leader in the discovery, development, manufacture, and sale of health care products to end users across the globe (United States Securities and Exchange Commission, 2013). By extrapolating performance indicators in the financial analysis of Abbott Laboratories, it will become apparent that the firm is suitable for capital investment within the parameters of this project.

The factors that go into the decision for determining its compatibility as a viable capital investment stock choice in this project assignment is through financial analysis and its fundamental building blocks––the reasons behind its success. Assessing the fundamentals, the essential building blocks of a stock that looks the fundamental financial ratios, cash flow, and balance sheet numbers, is critical to determining whether Abbott Laboratories is suitable for investment. Indeed, Abbott Laboratories has very impressive fundamentals backing the stock. Looking at Abbott Laboratories’ balance sheet, promising returns on investment are shown. The Gross Profit was shown to have reached 62% in 2012, which is a gradual increase from 2011 and 2010, with 60% and 58% documented respectively for Abbott Laboratories (Stock Analysis on Net, 2014). Abbott Laboratories’ market capitalization is $58.32 billion and has been able to achieve higher liquidity in 2012, with increase in cash flow to 23% in 2012, higher than ratios of 13% in 2011 and 9% in 2010 (Ho, 2013). However, long term liability ratios have increased to 41% in 2012 from 34% in 2011 and 33% in 2010 (S&P Capital IQ McGraw Hill Financial, 2014). This strategic move places them at a projected growth towards research and development, whereby it will make the most money.

By investing the free cash-flow into projects that gained the confidence of Abbott Laboratories, the firm is able to signal to the market that they are clear of their future developments. Abbott Laboratories has shown, throughout the past market decisions and choices, to be very conservative with their capital expenditures. Since they have shown and taken stock of using their free cash flow into projects, it can be speculated that they have gained insight into future progressions of their industry. Such actions that have been taken to maintain their standards and products signal to the investor their stability and consistency, which makes them less risky and more profitable in the long run. Worthy evidence demonstrating the company’s viability in the market is looking through their dividend payout ability. Abbott Laboratories has successfully raised their quarterly dividends 57% to $0.22 a share, from the previous $0.14 a share, payable on February 15th, 2014 to shareholders that are on record prior to or on January 15th, 2014 (S&P Capital IQ McGraw Hill Financial, 2014). Even JP Morgan holds the firm’s reputation and progression in high esteem as they estimate that sales growth for Abbott will be from 5 percent to 5.5 percent annually in the next five years whereas this number for brand name segment is 1.5 percent annually (Ho, 2013). While projections maintained by different analysts may be inconsistent and different from one another, existing financial indicators will be able to prove that Abbott Laboratories is worth the capital investment for this project.

Financial analysis of Abbott Laboratories should be focused on three principal determinants, including the discounted rate on the IRR, or Internal Rate of Return, NPV – Net Present Value, and the Payback Period for the project company stock, which is Abbott Laboratories in this case. Through conducting a general scope projection and assessment outlook of these figures, it will come to be seen that Abbott Laboratories is prime for investment based on its projected profitability in the future. Furthermore, since these numbers also gauge the time value of money, it will become apparent that the Net Present Values of the stock support its purchasing price, as evidenced in the stock market financial theory.

Net present value and projected Net Present value MMA (Money Market Account) are very useful tools that can determine the fair value of the project’s stock price and as well as its earning capabilities in the future. According to Kobzeff (2012) Net Present Value can be calculated by subtracting the initial investment from the present value, while the Net Present Value MMA is calculated based on a hypothetical $1,000 capital investment, where it is the cumulative differences between the dividend earning of the investment and interest income that would be received from the MMA over 20 years (Dividends Value, 2010). Should the net present value of project be positive, it would imply that present value of cash inflows expected in the future is more than the present value of all capital expenditures. However, should the net present value of the project be negative, the present value of cash inflows expected in the future is less than the present value of all capital expenditures.

Looking into Abbott Laboratories’ Net Present Value MMA price, we see convincing numbers for its investment based on sound NPV MMA projections and as well as discount rate flow projections in the future. As presented by Dividends Value (2010), the Net Present Value MMA price is projected to be $66.87 by the next 5 years. Since current stock price hovers around the $39.59 (as of 2/26/2014), it is almost $27 dollars away from hitting its MMA price within the next 5 years. Furthermore, since the Net Present Value is estimated at $38.05, with a discounted cash flow rate of approximately 15 percent as of 2010, the positive figures demonstrate that Abbott Laboratories still has a wide room for growth and as well as will be a wise choice for capital investment. Hence, the NPV and the discount rate ratio of the stock can be interpreted as in favor of the stock of Abbott Laboratories, since it still has tremendous growth opportunities in the future.

Since it is the discount rate which makes net present value of a project equal to zero of total return through time, it is a critical asset when considering investment in Abbott Laboratories. Whether or not to invest in Abbott Laboratories must come under the scrutiny of the discount rate of its stock, by converting future sum of money into a current sum by discounting the value of it, based on the fact that current payment is not expected, but simply the value in investing time into the project (Boehje & Ehmke, 2005). The discount rate, as according to Ho (2013), or the Weighted Average Cost of Capital for Abbott is around 6 percent, which makes it a likely candidate for investment. The weighted average cost of capital, or discount rate, signifies that while Abbott Laboratories is a profitable venture, as the 6 percent is above 0, which shows that it is in fact profitable and growing. However, the 6 percent it does not boast an overwhelming return, as the bigger the discount rate, the more the return. Nonetheless, since the project generates returns which are greater than this return to create value for the company, it is a solid candidate for the capital investment due to its consistency and stableness.

Rate of Return on Equity (ERR) on a stock is an important measure to what the rate of money earned back, and how long it would take the firm to return the amount of money that were invested in the company. The rule that should be followed for an investment project is If ERR is greater than company’s cost of capital, project should be accepted. If ERR is less than company’s cost of capital, then the project should be denied. Return on revenue for Abbott Laboratories registered at 15 percent, on the other hand, shows that it maintains its leadership position as the figure outperforms the majority of its sub-industry peers in the GICS category. According to S&P Capital IQ (2014), towards the beginning of 2013, Abbott Laboratories revealed that the firm had significant cash flow generation capability upward of $4 billion, which also outperforms its peers in the industry.

According to YCharts (2013), the rate of return on equity on the stock for Abbott Laboratories is 10.69 percent, or almost 11 percent, as of December 2013, it can be generalized that the firm can recoup initial investment in 10 years (Ycharts, 2013). However, such generalizations also depend on the variety of factors that can affect the stock and its future progressions and developments based on the differing market climates. Payback period is the time it takes to recover the initial investment of the project. Shorter the payback period, more feasible is the project. Once it is clear that the project should be undertaken, its financial feasibility should be evaluated. However, since Abbott Laboratories occupies such a large market share within its industry, it also has much access to debt services. The discounted cash flow analysis put the stock price higher than the current level as AbbVie has absorbed approximately 70 percent of the stock’s debt services (Ho, 2013). Even after the transfer of debt service, the debt utilization ratio for Abbott Laboratories improved from 2010 to 2011, it deteriorated slightly from 2011 to 2012 that recorded similarly as with its debt-to-capital ratio (Stock Analysis on Net, 2014). This signals that the company has enough capital and cash flow to grow its company, so if the company would finance the project from equity funds, feasibility analysis is not required.

Tax advantages and dividend producing factors are also indicators in favor of purchasing Abbott Laboratories. As of right now, Abbot Laboratories has reportedly been increasing dividends at a rate of 10 percent annually consecutively for the previous 5 years, it has also been projected that dividends will grow to 4.6 percent when AbbVie and Abbott Laboratories combine forces in 2013, which is .88 cents per share (Abbott Laboratories, 2014). Earnings per share on Abbott Laboratories are documented at .58 dollars, which has fallen short of analyst expectations for the 2014 analyst expectations, but still better than most of the industry figures (Thompson Reuter, 2014). Tax rate ratio, on the other hand, decreased dramatically in 2012 to 4.79%, from 9% and 19% in 2011 and 2012, respectively (Morningstar, 2014). Such a tax advantage would give more leverage to Abbott Laboratories in earning more revenue and paying back its investors.

In determining the return on investment, factors like risk should be considered. It is the return that investors would expect considering other capital investments and the capital structure of the firm in its competitive stance amongst those in the industry. While Ho (2013) has stated that the risk level for the stock of Abbott Laboratories is moderate, many other analysts opine that their risk level is even lower. Thompson Reuter’s stock analysis (2014), for example, shows that the stock risk rating is at 8, one a scale of 1 to 10, with 10 being the lowest in volatility. This risk average for Abbott Laboratories primarily arose from its consistent returns and growth patterns on revenue, which shows that it is ahead of its competition as the pharmaceutical group and medical research sector has an average of high volatility of risk, at 3.8 and 2.8 respectively on the risk analysis chart.

Hence, from all the above indicators, it is noted that the stock of Abbott laboratories is currently undervalued, both due to its Net Present Value MMA fair value price and as well as its discount ratio. Recent drop in stock price for Abbott Laboratories is primarily due to ambiguity among investors regarding the separation of Abbott and AbbVie companies, leading to confusion and hence panicked sell-off of the stock (Ho, 2013). Therefore, it has been shown that the sell-off is unwarranted and the stock, is indeed, ready for recognized uptrend and growth. The company has had strong fundamentals supported by financials. Hence, I believe that Abbott would be a good investment over the long term.

References

Boehlje, M., & Ehmke, C. (2005). Capital investment analysis and project assessment. Retrieved from https://www.extension.purdue.edu/extmedia/EC/EC-731.pdf

Dividends Value (2010). Abbott Labs. Retrieved from http://content.dividendsvalue.com/Reports/2010/04/ABT.2010.04.24.pdf

Ho, L. (2013). Abbott Laboratories. Educational Investment Fund, The M.J. Neeley School of Business.

Kobezeff, J. R. (2012). Understanding net present value: Knowing whether the real estate investment achieves your desired yield! Retrieved from http://jamesrk.hubpages.com/hub/Real-Estate-Net-Present-Value

Morningstar (2014). Growth, Profitability, and Financial Ratios for Abbott Laboratories (ABT). Retrieved from http://financials.morningstar.com/ratios/r.html?t=ABT®ion=usa&culture=en-US&ownerCountry=USA

S&P Capital IQ McGraw Hill Financial (2014). Stock report: Abbott Laboratories. Retrieved from https://research.ameritrade.com/grid/wwws/common/reports/report.asp?id=10072&documentTag=00282410&vtag=4KL6GRSDCUFTMOEMUNTB3AI919

Stock Analysis on Net (n.d.). Abbott Laboratories (ABT) | Common-size income statement. Retrieved from http://www.stock-analysis-on.net/NYSE/Company/Abbott-Laboratories/Common-Size/Income-Statement

Thomson-Reuters Stock Reports+ (2014). Abbott Laboratories - Detailed Stock Reports. Retrieved from https://research.scottrade.com/qnr/Stocks/GetPDF?docKey=1581-0091N-126EM2P9BB5HM633SV6GB2LA9V

United States Securities and Exchange Commission (2013). SEC FILING | Abbott Form 10-Q (1-2189). Retrieved from http://services.corporate-ir.net/SEC.Enhanced/SecCapsule.aspx?c=94004&fid=9091100

YCharts (2014). Abbott Laboratories Return on Equity (TTM) (ABT). Retrieved from http:// ycharts.com/companies/ABT/return_on_equity