By: Ahmed Ishtiaq
Abbott Laboratories (NYSE:ABT) has taken a new shape after the spinoff. After the separation of AbbVie (ABBV), we will now have a clear idea of how profitable are the nutritionals, devices, diagnostics, and established pharmaceuticals segments. At the moment, Abbott is not as profitable as some of its competitors. The margins are quite high in the industry; however, Abbott has not been able to exploit the opportunity. Nonetheless, the company reported impressive earnings for the fourth quarter of 2012. Abbott exceeded the market expectations by $0.01 per share. We decided to perform a fair value analysis for Abbott using out discounted earnings model.
As of January 31, 2013, ABT stock was trading at around $36.39, with a 52week range of $33.33  $38.52. It has a market cap of about $53.6 billion. The trailing twelvemonth P/E ratio of 8.1 is slightly lower than the forward P/E ratio of 9.2. P/B, P/S, and P/CF ratios stand at 1.9, 1.4, and 5.8, respectively. The operating margin is 19.7% while the net profit margin is 16.6%.
Abbott has a 3star rating from Morningstar. The majority of analysts covering Abbott have a strong buy recommendation for the stock, and they expect the stock to outperform the sector. Wall Street has diverse opinions about the company's future. The average fiveyear annualized growth forecast estimate is 9%.
We can estimate Abbott's fair value using a discounted earnings plus equity model as follows.
Discounted Earnings plus Equity Model
This model is primarily used for estimating the returns from longterm projects. It is also frequently used to price fairvalued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5+ Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my estimates. You can set these parameters as you wish, according to your own diligence.
Valuation
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate.
In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year. The average EPS for Abbott is $1.92.
Wall Street holds diversified opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average fiveyear growth forecast is 9%. Book value per share is $17.27.
Fair Value Estimator  
V0 
E_{0} 
$1.85 
V1 
E_{0} (1+g)/(1+r) 
$1.82 
V2 
E_{0}((1+g)/(1+r))^{2} 
$1.78 
V3 
E_{0}((1+g)/(1+r))^{3} 
$1.75 
V4 
E_{0}((1+g)/(1+r))^{4} 
$1.72 
V5 
E_{0}((1+g)/(1+r))^{5} 
$1.69 
D 
E_{0}(1+g)^{5}/[r(1+r)^{5}] 
$15.36 
BV 
Equals 
$17.27 
Fair Value Range 
Lower Boundary 
$25.97 
Upper Boundary 
$43.24 

Potential 
27.62% 
(You can download FED+ Fair Value Estimator, here.)
I decided to add the book value per share so that we can distinguish between a lowdebt and debtloaded company. The lower boundary does not include the book value. According to my 5year discountedearningsplusbookvalue model, the fairvalue range for ABT is between $25.97 and $43.24 per share. At a price of about $33.80, Abbott is trading at a price within its fair value range. The stock still has up to 27% upside potential to reach its fair value maximum.
Comparison with Peers
Abbott peers include Johnson & Johnson (NYSE:JNJ), Pfizer Inc. (NYSE:PFE) and Novartis (NYSE:NVS). The table below lists some important metrics for comparison.
ABT 
JNJ 
PFE 
NVS 

P/E 
8.1 
24.3 
21.2 
17.4 
P/B 
1.9 
3.2 
2.5 
2.4 
P/S 
1.3 
3.1 
3.3 
2.9 
EPS Growth 
1.20% 
8.60% 
1.90% 
1.80% 
Operating Margin 
19.70% 
23.80% 
26.50% 
20.00% 
Net Margin 
16.60% 
12.90% 
15.60% 
16.50% 
ROE TTM 
25.30% 
13.60% 
11.30% 
14.10% 
Debt to Equity 
0.40 
0.20 
0.40 
0.20 
Source: Morningstar
Abbott is currently trading at a discount compared to its peers. EPS growth figures are poor for almost all the participants in the industry. However, Abbott has the worst operating margin compared to its peers. On the other hand, net margin for the company is better than its peers. Furthermore, the debttoequity ratio is in line with the industry.
Summary
Abbott has to improve its margins as the company is currently falling behind its competitors. Our valuation model indicates that there is substantial upside potential in the stock. There are a lot of growth opportunities in the market, which the company needs to exploit. I believe the separation of operation will allow the company to focus better. As a result, the operational efficiency of Abbott will improve. At the current price levels, Abbott represents an attractive investment opportunity.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: Efsinvestments is a team of analysts. This article was written by Ahmed Ishtiaq, one of our equity analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.