A lesson in valuation: Why we would buy AbbVie over Apple, despite the hype

Lorne Zeiler: Both Apple and AbbVie are excellent companies, but only AbbVie is being offered at a great price

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Apple Inc. shares were soaring earlier this week after the company’s 4-for-1 stock split became official. While there is no question that Apple is a fantastic company and has a great platform for stable and potentially growing earnings, the question an investor should ask is, “Is it a good buy at current prices?”

I have chosen to compare Apple to another large-capitalization stock that also starts with ‘A’, AbbVie Inc., a leading pharmaceutical company, to highlight the massive valuation gap. Since the beginning of the year, Apple shares have increased in value by more than 75 per cent, while AbbVie shares have only increased by seven per cent. But guess which one has had more earnings growth and pays a higher dividend?

Growth

Investors often argue that Apple is worth its premium valuation due to its great growth profile. Given Apple’s 75 per cent increase in share price this year, one would expect its earnings growth to be soaring — instead it has barely budged (Table 1). In fact, the annual earnings growth from 2018 to 2022 (estimated) is only nine per cent per year. Growth companies by comparison are typically growing at 20 per cent or more per year.

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By comparison, AbbVie has been growing earnings at a faster pace. Earnings growth has averaged 14 per cent over the same period, again lower than most growth companies, but a 50 per cent higher earnings growth rate than Apple.

Income

One of the ways to value companies is the dividend discount model, which calculates the expected cash flows an investor expects to earn from an investment. In the mid-2000s, to address a lower valuation, Apple introduced a dividend payment and was aggressively buying back shares. Apple has since decreased its share buyback program (as a percentage of total shares outstanding) and at current prices, pays a dividend of only 0.6 per cent.

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AbbVie, by comparison, pays a dividend of more than 5.1 per cent and historically has increased its dividend payment by approximately 20 per cent per year.

Risks

One of the key risks weighing on AbbVie’s stock has been its marquee drug, Humira, which has been one of the best-selling medications in the past few years. Humira lost its patent protection in Europe this year and is likely to lose it in the U.S. by 2023. AbbVie though has demonstrated its earnings diversity as newer medications such as Imbruvica, Rinvoq and Skyrizi are growing sales at more than 25 per cent per year. In fact, Humira is now responsible for a decreasing percentage of AbbVie’s total sales. Last quarter, Humira was responsible for 46 per cent of total sales vs. more than 70 per cent just a few years ago. At the same time, total sales were growing significantly. AbbVie also owns a cosmetic line of medications, Botox, in particular, from its Allergen acquisition to further diversify earnings.

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A screen displays the stock price of AbbVie on the floor of the New York Stock Exchange in 2014.
A screen displays the stock price of AbbVie on the floor of the New York Stock Exchange in 2014. Photo by Brendan McDermid/Reuters files

Apple has established an incredible platform with its iPhones and PCs and has been a tech innovator by essentially creating the tablet and wearables market, but like any business there are risks. For Apple, they are primarily around the potential for anti-trust legislation, particularly concerning its App store (this has been the largest growth area for Apple’s earnings) which charges a rate of 30 per cent of the entire sales price for any downloaded applications. Epic Games, the maker of the popular video game Fortnite is suing Apple over its App store pricing and last month Apple was asked specifically about the pricing by Congress. Apple also continues to be caught in the ongoing dispute between the U.S. and China. Apple has already had to change its production and supply chain as a result, but if some of the Chinese programs, such as WeChat have to be removed from iPhones, revenues in China, Apple’s second biggest market, could also drop significantly.

Valuation

Warren Buffett has stated that “price is what you pay, value is what you get.” It seems that you get much more value from AbbVie. Apple is essentially earning about three per cent more than it did in 2018, yet its share price is nearly 140 per cent higher ($134/share vs. $56/share on Sept. 1, 2018, adjusted for stock split), i.e. nearly all of its share price appreciation has been from its price-earnings multiple increasing from 18 times earnings to over 42 times earnings currently. Even if you look out to 2022, Apple is still trading at over 31 times earnings and offering a sub one per cent dividend yield.

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AbbVie is expected to earn 3.3 times as much as Apple per share this year and yet its shares are trading at roughly 70 per cent of Apple’s share price. Consequently, its price-earnings ratio is cheap at nine times earnings and if you look out to 2022, it is trading at only seven times projected earnings. In addition, by 2022, you would have also earned over 10 per cent in dividend payments.

It also should be noted how astronomical Apple’s valuation is. Its current market capitalization is US$2.25 trillion, this is over 25 per cent more than the entire GDP produced by Canada in 2019.

Buying great companies at great prices makes for profitable long-term investments. Both Apple and AbbVie are excellent companies, but only AbbVie is being offered at a great price.

Lorne Zeiler, MBA, CFA is portfolio manager and wealth adviser at TriDelta Financial, a boutique wealth management firm focusing on investment counselling and estate planning. He can be reached at lorne@tridelta.ca.

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