Johnson & Johnson's Dividend Hike: Why 6.5% Works

In recent days, almost everyone was expecting a dividend hike announcement from Johnson & Johnson (JNJ). Predicting an increase wasn't a tough call. JNJ had raised their dividend for 44 years in a row. What was a tough call was the amount of the hike.

On April 23, they announced a 6.5% dividend increase. In these days of dividend cuts, I applaud JNJ's hike, but I thought it was a bit light. The estimates ranged from 6% to 9.5%. The consensus was in the 8% range.

With earnings over the last twelve months having risen nearly 9.5%, I was hoping for an increase between 8% and 9.5%, say 8.5%. Thus, the increase of 6.5% was at first a bit disappointing.

To find reasons why the hike was less than expected is not a tough task. The current administration seems bent on sticking their noses and fingers deeper and deeper into America's economic system. With the administration's talk of big changes to our current health-care reimbursement programs, JNJ may be signaling a new, less optimistic view of their long-term prospects. That notion is also born out by Wall Street analysts' 3-5 year forward earning estimates for JNJ, which are now at 8%.

In these days of weak earnings reports, 8% long-term growth sounds exceptional, but in JNJ's case that is far lower than their last 5-year earnings growth rate of 11.5%. Indeed, current estimates project that 2009's earnings will be about flat with 2008.

As I think about it, however, I believe JNJ is just being pragmatic. I think they are building in a cushion that will enable them to hike their dividend again in 2009 when earnings growth may be meager. I just can't be too pessimistic about a company that has done as many things right over the last 20 years as has JNJ.

Furthermore, is it not remarkable that JNJ is currently selling at about 11 times trailing 12-month earnings. That is about half their 20-year average of 22x. Combine this low PE with a dividend yield of almost 4% and you have one of those old fashioned "value" stocks. Funny, I always thought JNJ was a growth stock. These metrics, however, would suggest that it is now being priced like a value stock. That seems odd especially when we consider it has a strong consumer brand (33% of sales) that is not encumbered by health-care pricing issues.

In these days, it is very easy to beat up on any stock, but I have a very strong feeling that investors are underestimating JNJ's broad product line and worldwide clout.

Disclosure: Author owns JNJ

Comments

[David Van K...:]

The fact that JNJ's past 12 months' earnings were up 9.5% is not all that relevant. While those earnings provide the pool out of which dividends are paid, the dividend declaration itself is forward-looking. Company management is figuring out how to spend its profits in light of all its plans, needs, and outlook for the future.

In JNJ's case, with its long history of raising dividends, there is also a cultural imperative--tantamount to policy--not to raise the dividend to any amount that it would have to freeze (or cut) in the future.

Taking all this into account, I'm more than happy with the 6.5% increase. Only the strongest companies are increasing dividends by that much or more. Many long-term-increasers are raising their dividends by only token amounts this year, and more than a handful have given up entirely, freezing or cutting their dividends for the first time in years or decades.

As an owner of JNJ, I want management to be prudent with the profit pool. Dividend investing is a long-term strategy. I want JNJ to be pumping out increasing dividends for many years to come. I would conclude that management sees the next couple years as a little tougher than most, maybe a little hazy, but overall they'll do just fine. That's fine with me.

Apr 28 10:31 AM

[ej1234:]

You will not see 22x earnings on this company for probably another 30 years. The entire market has been in a bubble since 1994; there is nothing normalized about a 10-year average EPS P/E ratio between 20 and 43. Get used to seeing multiples hover between 8 and 18 going forward with more emphasis on the lower end of that range. Based on a 7-year average of earnings, JNJ is fairly priced. A dividend of 4% is nothing special historically. This generation has, unfortunately, been spoiled with nothing but rising markets making dividend yields seem irrelevant. However, the historical (130 years) average yield on the S&P 500 is about 4.5%. Right now, it's 3.3% - still a long way to go.

Apr 28 01:19 PM

[richjoy403:]

Yikes! >You will not see 22 times earnings on J&J for probably another 30 years>

No intelligent person thinks they can make an earnings projection 30 years out. Therefore, all that follows that forecast has little or no credibility.

Nov 19 06:25 AM