Sell Johnson & Johnson As It Is Over Extended

| About: Johnson & (JNJ)

Johnson & Johnson (NYSE:JNJ) shares have been on a tear since the start of the year, at precisely the start of the year to be exact. That smells of fiscal cliff relief and capital flow thunder, which has been a good enough reason for the broader market and one I suggested would drive stocks higher as well. However, I see the stock extended now in terms of valuation. Therefore, nimble money could reduce holdings here, and longer-term funds may seek value elsewhere as well.

J&J shares have not only tagged along with the Dow Jones Industrials Average and the S&P 500 this year, but have helped to drive the indexes higher, since they are an important component of each. The chart here comparing the SPDR S&P 500 (NYSEARCA:SPY) and the SPDR Dow Jones Industrial Average (NYSEARCA:DIA) to the performance of Johnson & Johnson shares shows the parallel rise and illustrates that the move in all three is very likely on the same driver.

Chart forJohnson & Johnson

Chart at Yahoo Finance

The driver is capital flows coming into stocks in a big way since the turn of the year. Capital was freed up once Washington D.C. got out of the way of the market. The mitigation of the fiscal cliff (for the most part) and the attention given to the debt ceiling and the full faith in credit in the United States allowed investors to focus on the economic improvement they are now forecasting with their dollars. I have noted the strong capital flows into equity mutual funds over the last several weeks, with money coming out of money market funds and gold and precious metal relative securities like the SPDR Gold Trust (NYSEARCA:GLD) and the iShares Silver Trust (NYSEARCA:SLV). In this regard, and after the recently supportive Employment Report (despite my contest of it), I suggested investors continue adding some beneficiaries of capital flows and selling other securities being harmed by them.

Johnson & Johnson shares would fall into the group benefiting from capital flows, except for one issue, valuation. JNJ shares trade at a current P/E of approximately 20.3X their trailing 12 months' EPS. Not only is this valuation above JNJ's five-year average P/E of 15.5X, but it's above the average high P/E over that span. In fact, the current valuation represents the high for the last five years. For those who might argue that the last five years have not been good years, I would suggest that consumer staple and healthcare stocks should see more demand for capital in such times versus comparable sectors, and so carry a premium valuation. Certainly the stock's beta coefficient of 0.45 would indicate that it is less than correlated with the broader cyclical stock market.

Looking now at value in comparison to growth, the stock's P/E ratio is about 14.6X the analysts' consensus estimate for this year. EPS growth this year is estimated at just 6.1% by the analysts' consensus. EPS growth for the next two years is estimated at 6.3% on an average annual basis, and the five-year forecast is for 6.35%. Even applying the highest growth forecast (five-year), the PEG ratio for JNJ is 2.3, which is high.

On a relative basis, based on Yahoo Finance data, JNJ's P/E ratio of 14.6X the 2013 EPS consensus is higher than both its listed industry (Major Drug Manufacturers) average of 10.4X and the sector (Healthcare) average of 14.3X. It's difficult to find a perfect comparable to JNJ, because of its participation in three main segments, consumer, pharmaceutical and medical devices and diagnostics. Obviously, you would want to value each segment to its industry comparable and weight them by the importance they bear upon the company's earnings or perhaps revenue. JNJ trades at a higher P/E ratio and price-to-sales ratio than consumer goods peer Procter & Gamble (NYSE:PG), but its PEG ratio compares relatively well to that of PG and Kimberly-Clark (NYSE:KMB). Looking at healthcare comparables Covidien (COV), Novartis (NYSE:NVS) and Pfizer (NYSE:PFE), JNJ trades at a P/E premium to each, but in terms of PEG it compares more favorably.

I believe that in the cases where JNJ matches well with its peers, its peers are also overvalued. I believe this is because of the demand for consumer staple and healthcare stocks in recently less than sanguine economic environment of the last several years. It is my view that the latest capital flow funding coming into equities is also benefiting the already favored staples and healthcare shares like JNJ. It's my view though that these stocks are getting too pricey and that capital will become increasingly discriminating as the rally ages. For this reason, and based on all of the above valuation metrics, I would sell JNJ in focused portfolios and reduce exposure in broader pools where relative securities must be held.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.