AbbVie's Outsized Dividend Has The Stock Undervalued

| About: AbbVie Inc. (ABBV)

Summary

AbbVie recently announced a quarterly dividend of $0.57 per share with an ex-dividend which is on October 12th, making the must-own date October 11th.

The company has been increasing its dividend for the past four years.

The stock is undervalued by about 159% from today's price of $62.93.

A dividend is just one of many ways a company can reward its shareholders by paying them out in cash. The investor can then choose to take the cash and run, reinvest it in the company, or invest it in a different company. After a company has made its net income for the quarter, it has the choice of what to do with it, and the choices are usually to either plow the money back into the business for other investments or pay some of that money back to shareholders in the form of a dividend.

Most Recent Dividend Announcement

AbbVie (NYSE:ABBV) recently announced a quarterly dividend of $0.57 per share with an ex-dividend which is on October 12th, making the must-own date October 11th. This dividend announcement is on par with what was announced in the previous quarter. The dividend will be payable to owners on November 15th. The dividend is currently good for a 3.6% yield on today's share price of $62.93. Based on trailing earnings, the dividend is good for a payout ratio of 65%, which is pretty good for now. From a cash flow perspective, the company has paid $3.5 billion in dividends over the past twelve months on operating cash flow of $8.2 billion, which is good for a 43% operating cash flow payout ratio.

Potential Future Dividends

AbbVie has been increasing its dividend for the past four years. It is projected to earn $5.65 per share in earnings for next year, and if the EPS payout ratio remains the same at 65%, then the company should distribute about $3.68 annually starting 2017 (or a 61.1% increase). That amount seems pretty high, and I do not believe the 52% payout ratio is sustainable for the long term.

Earnings growth projections for AbbVie are pretty good for a major drug manufacturing company with a one-year growth rate of 17.4% and a five-year growth rate of 16.3%. With that said, I believe a 16% increase to the dividend next year would be much better because it would be safer. A 16% increase would constitute an annual dividend of$2.64 for 2017 if the company increases the dividend in 2017.

Dividend Valuation

Now let's get to the meat and potatoes, the dividend valuation model to determine a price that the stock should be at based on the dividend alone. Since I just mentioned that the company has been increasing its dividend for the past four years, we know that it has a pretty small history of increasing it, and should continue to increase it going into the future. The dividend growth model equation takes the form of:

Annual Dividend (D)

Rate of Return (R) - Dividend Growth Rate (G)

Click to enlarge

Where D is equivalent to the current dividend, R is the rate of return desired by the investor, and G is the anticipated growth rate of the dividend. For the D value, I'm going to use the existing dividend rate of $2.28.

For the R value, I'm going to use 17.4% because it is next year's earnings growth estimate. For the G value of the equation, I'm going to use a dividend growth rate of 16% because I definitely believe the company could increase the dividend by that much at least for the next year to keep investors happy. When you plug and chug all the numbers, you get a stock value of $163, which makes the stock undervalued by about 159% from today's price of $62.93. For reference, the 52-week high on the stock was $68.12 during August of this year.

Conclusion

The dividend discount model is just one of many ways to value a company and should be taken into consideration while trying to evaluate a company. Assumptions are always made while using valuation models, and I believe I've selected some of the most conservative criteria for valuation in this article. This valuation model shows the value of the dividend stream, and that the stock is undervalued based on the dividend alone. AbbVie has been around for quite some time and can definitely afford to increase the dividend when 2017 comes around.

It currently trades at a trailing 12-month P/E ratio of 18.04, which is fairly priced, but I mainly like to purchase a stock based on where the company is going in the future as opposed to what it has done in the past. On that note, the 1-year forward-looking P/E ratio of 11.14 is currently inexpensively priced for the future in terms of the right here, right now. Next year's estimated earnings are $5.65 per share, and I'd consider the stock inexpensive until about $85 with a P/E valuation method. The 1-year PEG ratio (1.04), which measures the ratio of the price you're currently paying for the trailing 12-month earnings on the stock while dividing it by the earnings growth of the company for a specified amount of time (I like looking at a 1-year horizon), tells me that the company is fairly priced based on a 1-year EPS growth rate of 17.4%. AbbVie has great near-term future earnings growth potential with a projected EPS growth rate of 17.4%. In addition, the company has great long-term future earnings growth potential with a projected EPS growth rate of 16.25%.

I actually initiated my position in AbbVie in early June and have been pretty ambivalent with the purchase thus far. So far, I'm up 5.6% on an annualized basis, but will not purchase shares until they get below $56, because I believe that is where it offers additional value. I've selected $56 because it is the midway point of the 52-week range.

I swapped out of Seagate (NASDAQ: STX) for AbbVie during the 2016 second-quarter portfolio change-out because I ended up turning a profit in the name (6.2%, or 21.3% annualized) and wanted to lock in those profits. Since the swap, I have lost out on a lot of gains, as Seagate has outperformed the market and AbbVie since the swap. For now, here is a chart to compare how AbbVie and Seagate have done against each other and the S&P 500 since I swapped the names.

Click to enlarge

It doesn't look like the trade has worked out from the chart, and that is because it is still too short of a holding period. However, I am actually up 1.9% on the name because it has been a short holding period so far. For now, I'm going to hold off on making purchases in the name because it is above the level at which I made my initial purchase.

Disclaimer: This article is in no way a recommendation to buy or sell any stock mentioned. This article is meant to serve as a journal for myself as to the rationale of why I bought/sold this stock when I look back on it in the future. These are only my personal opinions and you should do your own homework. Only you are responsible for what you trade and happy investing!

Disclosure: I am/we are long ABBV.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.