Stock Analysis

An Intrinsic Calculation For Abbott Laboratories (NYSE:ABT) Suggests It's 32% Undervalued

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NYSE:ABT
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Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Abbott Laboratories fair value estimate is US$145
  • Current share price of US$98.19 suggests Abbott Laboratories is potentially 32% undervalued
  • Analyst price target for ABT is US$121 which is 16% below our fair value estimate

In this article we are going to estimate the intrinsic value of Abbott Laboratories (NYSE:ABT) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Abbott Laboratories

What's The Estimated Valuation?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) US$8.63b US$8.73b US$9.31b US$10.8b US$13.2b US$14.6b US$15.8b US$16.7b US$17.6b US$18.3b
Growth Rate Estimate Source Analyst x5 Analyst x6 Analyst x4 Analyst x2 Analyst x1 Est @ 10.54% Est @ 8.00% Est @ 6.22% Est @ 4.98% Est @ 4.10%
Present Value ($, Millions) Discounted @ 7.5% US$8.0k US$7.6k US$7.5k US$8.1k US$9.2k US$9.4k US$9.5k US$9.4k US$9.1k US$8.8k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$87b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 7.5%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$18b× (1 + 2.1%) ÷ (7.5%– 2.1%) = US$342b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$342b÷ ( 1 + 7.5%)10= US$165b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$252b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$98.2, the company appears quite undervalued at a 32% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
NYSE:ABT Discounted Cash Flow March 14th 2023

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Abbott Laboratories as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 7.5%, which is based on a levered beta of 0.920. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Abbott Laboratories

Strength
  • Debt is not viewed as a risk.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Earnings declined over the past year.
  • Dividend is low compared to the top 25% of dividend payers in the Medical Equipment market.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Annual earnings are forecast to grow slower than the American market.

Moving On:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value higher than the current share price? For Abbott Laboratories, there are three relevant elements you should assess:

  1. Risks: As an example, we've found 1 warning sign for Abbott Laboratories that you need to consider before investing here.
  2. Future Earnings: How does ABT's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

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