Seeking Alpha
Profile| Send Message|
( followers)  

By: Ahmed Ishtiaq

Johnson & Johnson (NYSE:JNJ) is a diversified health care giant operating in three segments through more than 250 companies located in some 60 countries. Its Medical Devices and Diagnostics division offers surgical equipment, monitoring devices, orthopedic products, and contact lenses, among other things. J&J's Pharmaceuticals division makes drugs for an array of ailments, such as neurological conditions, blood disorders, autoimmune diseases, and pain. Top sellers are psoriasis drug Remicade and anemia medication Procrit. Its Consumer business makes over-the-counter drugs and products for baby, skin, and oral care, as well as first aid and women's health.

As of January 28, 2013, JNJ stock was trading at around $73, with a 52-week range of $61.71 - $74.00. It has a market cap of about $204 billion. The trailing twelve-month P/E ratio of 24.3 is far above the forward P/E ratio of 12.4. P/B, P/S, and P/CF ratios stand at 3.2, 3.1, and 13.3, respectively. The operating margin is 23.8% while the net profit margin is 12.9%. The company has a reasonable debt load, with a debt/equity ratio of 0.2.

Johnson & Johnson has an impressive dividend profile. The company has a rich history of dividends and has increased dividend payment every year since 1997. At the moment, the company pays $2.44 in annual dividends, which represents a yield of 3.31%. JNJ has a relatively high payout ratio of 77% based on its earnings.

Johnson & Johnson has a 4-star rating from Morningstar. Majority of the analysts have a strong buy recommendation for the stock, and they expect the stock to outperform the sector. Wall Street has diverse opinion about the company's future. Average five-year annualized growth forecast estimate is 7%.

We can estimate Johnson & Johnson 's fair value using discounted earnings plus equity model as follows.

Discounted Earnings Plus Equity Model

This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued 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 Johnson and Johnson is $5.45.

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 five-year growth forecast is 7%. Book value per share is $23.1.

 

 

Fair Value Estimator

V0

E0

$5.45

V1

E0 (1+g)/(1+r)

$5.25

V2

E0((1+g)/(1+r))2

$5.06

V3

E0((1+g)/(1+r))3

$4.88

V4

E0((1+g)/(1+r))4

$4.71

V5

E0((1+g)/(1+r))5

$4.54

D

E0(1+g)5/[r(1+r)5]

$41.24

BV

Equals

$23.10

Fair Value Range

Lower Boundary

$71.13

Upper Boundary

$94.23

Potential

28.00%

(You can download FED+ Fair Value Estimator, here.)

I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for JNJ is between $71.13 and $94.23 per share. At a price of about $73, Johnson & Johnson is trading at a price within its fair value range. The stock still has up to 28% upside potential to reach its fair value maximum.

Competition

JNJ competitors include Novartis AG ADR (NYSE:NVS), Merck & Co Inc (NYSE:MRK) and Pfizer Inc (NYSE:PFE). The table below presents a comparison based on important metrics.

 

JNJ

NVS

MRK

PFE

P/E

24.30

17.40

19.70

21.00

P/B

3.20

2.40

2.40

2.40

P/S

3.10

2.90

2.80

3.30

EPS Growth

-8.60%

1.80%

-17.80%

1.90%

Operating Margin

23.80%

20.00%

18.60%

26.50%

Net Margin

12.90%

16.50%

14.20%

15.60%

ROE TTM

13.60%

14.10%

12.20%

11.30%

Debt to Equity

0.20

0.20

0.30

0.40

Source: Morningstar

At the moment, JNJ is expensive compared to its peers. However, a diverse revenue base, strong research pipeline and exceptional cash-flow generation create a wide economic moat. As a result, investors are happy to pay a premium for the stock. Furthermore, the company has strong operating and net margin. EPS growth figures of the industry show that the participants are struggling to grow EPS at the moment. However, operating and net margins remain strong in the industry. Moreover, all of the companies mentioned have a manageable debt to equity ratios.

Summary

According to my fair-value model, JNJ has substantial upside potential. In addition, the stock offers an attractive dividend yield. It is a relatively slow growth stock. However, it can be a great addition to an income portfolio. Furthermore, its stable growth provides a degree of stability to the portfolio. There are a few stocks, which provide solid income along with a stable growth rate. At the moment, Johnson & Johnson is one of these rare stocks.

Source: How Much Is Johnson & Johnson Worth?