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Warren Buffett has been selling the stock of Johnson & Johnson (JNJ) since 2011, despite the $215 billion healthcare giant's having a good run on the stock market recently. Although the reason for the spike may be the positive sentiments attached to the company's financial numbers, let's try and understand why Buffett is selling this stock.

The company has a very evenly distributed revenue stream. According to the company's 10-K report, Johnson & Johnson operates in three segments: Consumer, Pharmaceutical and Medical Devices and Diagnostics. Consumer segment includes revenues earned from products used in the baby care, skin care, oral care, wound care and women's health care fields, as well as nutritional and over-the-counter pharmaceutical products, and wellness and prevention platforms. In the financial year 2012, around 22% of the company's revenues were earned from this segment.

The second segment of the company is Pharmaceuticals. The products in anti-infective, antipsychotic, contraceptive, gastrointestinal, hematology, immunology, infectious diseases, neurology, oncology, pain management, thrombosis and vaccines are included in this segment. Around 38% of the company's revenues are earned from this segment.

The last and the most important segment for the company is the Medical Devices and Diagnostics segment, which includes products used by physicians, nurses, hospitals, and clinics. The products in this segment are used to treat cardiovascular disease, by orthopedic and neurological departments. Even products such as disposable contact lenses, energy products and infection prevention products are covered in this segment. Approximately 40% of the company's revenue is generated from this segment.

This diversified revenue stream is an encouragement for any investor, as it shows that Johnson & Johnson is not relying on any single product/brand or an area to generate its revenues. Even geographically, the company's revenues are distributed between the U.S. and its international operations. Around 45% of the revenues are generated internationally, while the rest domestically. And although this does expose the company to currency risks and general macro - economic risks of other countries, as an investor it provides cushion against relying on the U.S. market; especially in times when U.S. economists may have to take drastic steps to cut down its fiscal deficit. Cuts in the healthcare sectors are rumored.

Healthy Balance Sheet

The company's balance sheet also shows that the company is in a very strong position financially. As on 31st December 2012, the company had cash and equivalents worth $21 billion. That's almost 10% of the company's market value. And the company has such a strong cash position despite the fact that it repurchased shares worth around $12 billion in the previous year.

The current ratio of the company is 1.91. Although this does look very healthy, it does raise questions if the company is using its resources efficiently, and if there is value for the investors to be unlocked, perhaps through special dividend bonus.

The company has had a very health dividend program since past many years. Johnson & Johnson has been increasing its dividend payout consistently too, and in the year 2012, the company gave a total dividend of $2.40. The company is also expected to increase its quarterly dividend from $0.61, paid in the previous four quarters. And the company has not been compromising on its R&D expenditure either. The R&D cost in the year 2011 and 2012 were $7.5 billion and $7.7 billion respectively. These numbers would look encouraging for any company and instill confidence in investors.

Concerns

The biggest concern that the company has recently faced is the recall of many of its products from the counters and retailers for various reasons. Some of the major ones are, 12 million bottles of Motrin pain relievers recalled in Dec. 2011 for faulty product, 2,000 tubes of Aveeno Baby Calming Comfort Lotion were recalled as excessive levels of bacteria were found in the samples, and 574,000 bottles of the grape-flavored Tylenol because of flaws in its bottle design. And these are just very few in a very long list of products the company has had to recall in the past 5 years.

There are also numerous lawsuits ongoing against these faulty products. In a recent New Jersey order, the company had to pay $7.76 million in punitive damages to a South Dakota nurse who claimed she was harmed from the company's now-recalled Prolift vaginal mesh. In all more than 30 products have been recalled since 2009. All these various product recalls and lawsuits have had a very serious damage to the reputation of Johnson & Johnson.

Additionally, the company has a very high level of intangibles and goodwill on its books. Approximately $50 billion of the total $120 billion are Goodwill & Intangibles. The company's aggressive acquisition strategy is one of the major reasons for such high levels of intangibles. However, intangibles are susceptible to write offs, based on the failure of its products. Thus, the company's pipeline of new products is key to its future growth. Some of the company's products are nearing patent/market exclusivity. The company states on its website that LEVAQUIN lost its market exclusivity in 2011, and the sales of this product has declined 94% since then, once the competitors entered into the market.

Competition

Although the pharmaceutical industry is not prone to recession as such, it is extremely competitive in nature, not only in the United States but across the world. Most of the companies are competing for the same consumers, especially in the consumer segments in which Johnson & Johnson operates. The company's closes competitors are Novartis AG (NVS) and Pfizer Inc. (PFE). Both of these companies have a market capital of more than $150 billion and employee strength comparable to Johnson & Johnson. All three of these companies have approximately same operating margin as well as net income. Clearly, it comes down to which company is able to come up with better products at cheaper rates. And it is here that Johnson & Johnson needs to work very hard to win back market confidence. A customer will be more than willing to pay a few extra dollars for a good healthcare product than buy a product that is only a few dollars cheaper, but is from a manufacturer that has a history of faulty products.

Probable Reasons for Warren Buffett's Exit

Warren Buffett has gradually been selling JNJ since 2011. He is known to believe in and follow the fundamentals of the company. He is reportedly unhappy with the way management has handled the consistent faulty products over the last few years. The stock is trading at a two year high, and it seems to be a good time to exit the stock, just as Warren Buffett did. This is because the hit taken by the products and the brand in general are still not reflected in the company's results and its true effect will be felt over time. Thus, although the company may be able to salvage its good name over time, there is a good chance that the stock price may take note of the lawsuits and the potential loss of customers in between.

Source: Johnson & Johnson: Why Is Warren Buffett Selling This Stock?