There are many ways to categorize companies from an investment perspective. I reserve a special category for “Dividend Companies.” This is a term of art for me, not just a descriptive phrase. Merely paying a dividend is not enough for a company to make it into my “Dividend Company” category. Rather, that category is reserved for the best dividend companies, ones that are:
- excellent businesses
- financially healthy
- growing at a sustainable pace
- appear to present relatively low risk
- pay a sufficient yield at the time of purchase
- highly likely to increase their dividend every year
One such stock that seems perpetually to fulfill these requirements is Johnson & Johnson (JNJ). Let’s take a closer look at it.
Summary: J&J is a solid stock for the careful dividend investor. While its current yield of 3.1% is not breathtaking, its decades-long history of raising its dividend—47 consecutive years—is remarkable. The company would be called “blue-chip” by most investors, and this stock can be considered as a core holding for any dividend investor, whether they are in the wealth-building or income-harvesting phase of life.
Type of Company and Stock: In Morningstar’s Style Box, J&J is classified as a large core company. The “core” part means that the stock displays characteristics of both “growth” and “value” stocks. As to size, with a market cap of around $175 Billion, J&J is the 6th-largest U.S.-based company. Its medical devices and diagnostics division is the world’s largest and most diverse. Its pharmaceutical division would be, by itself, the world’s seventh-largest pharmaceuticals company.
J&J’s website is accessible here. All figures in this article are from Morningstar unless otherwise noted.
Company Story and Strategy: J&J, at 123 years of age, is the world’s most comprehensive manufacturer of health care products and related services. The company is divided into three segments: Consumer (24% of revenue); Pharmaceuticals (40%); and Medical Devices and Diagnostics (36%). J&J is in fact a holding company, with more than 250 operating companies located in more than 50 countries.
J&J is highly diversified. It would not be incorrect to call it a healthcare conglomerate. It is diversified across products, with scores of highly regarded brands. It is also diversified internationally, as it derives 47% of its revenue from abroad. The objective of any diversified strategy, of course, is to reduce risk, with oscillations in each segment tending to quell overall volatility. Over the years, this strategy has worked very well for J&J.
The company considers itself big and small all at once. J&J follows a decentralized operating approach, with each of its companies functioning as its own small business, yet also having access to the know-how and resources of a very large company and scores of strategic partners. J&J ranked #1 in Chief Executive magazine’s 2009 survey of the companies best at developing future leaders.
As with any pharmaceutical company, J&J must manage its branded drugs wisely, as at any given time some drugs are coming off patent and others are nearing the end of their patent lifetimes. (Sales of branded drugs drop significantly when patents expire and generic equivalents become available.) So to maintain financial continuity and growth, older drugs must be replaced with new branded drugs coming out of the company’s developmental pipeline or acquired from other companies.
J&J maintains a strong R&D spending ratio and is considered to have one of the strongest drug pipelines in the pharmaceuticals industry. The company is close to passing a difficult time in its patent cycle. For example, the company is nearing the end of the ramp-down phase from the patent loss on Topamax (which treats epilepsy, seizures, and migraines). During the past couple of years, J&J tightened its operations considerably, and it is expected to emerge as a more efficient company with a strong group of new drugs. Potential blockbuster drugs Stelara (for immunology diseases) and Simponi (for rheumatoid arthritis) were recently released. Another promising drug in the pipeline is Telaprevir (for hepatitis C), which also has the potential to be a blockbuster. A “blockbuster” drug is one with annual sales of more than $1 Billion.
In the medical device segment, J&J delivered 7% year-over-year growth in the most recent quarter (ignoring the effects of currency translations). Once very strong in drug-eluting stents, J&J has lost its leadership position, but it still remains a steady, slow-growth business. Other elements of the medical device segment are solid.
The consumer group posted 5% growth in the most recent quarter. International sales led the growth, a trend likely to continue as emerging countries continue to grow faster than developed nations.
Financials: Excluding the impact of foreign exchange rates, J&J recently reported total sales increases of 5% over the same quarter in the prior year, with each of the divisions contributing gains. (Including the impact of exchange rates, sales declined slightly.) As mentioned earlier, J&J responded to the recession aggressively with restructuring and cost-cutting, and those actions in turn supported faster earnings growth of 9% year-over-year (excluding one-time charges). Management’s full-year 2010 EPS guidance was in line with consensus expectations.
J&J has a remarkable long-term record of growth that few companies can match, including 25 consecutive years of adjusted earnings increases and 47 consecutive years of dividend increases. Analysts’ consensus expectations for the next 3 to 5 years of annual earnings growth are about 7%.
J&J has an excellent long-term record of allocating capital wisely. Fiscally conservative for decades, it is one of just a handful of companies with a triple-A credit rating. The company maintains a high ROE of 27% without goosing it with high debt. Its D/E ratio is a comfortable 0.2.
Dividends: J&J has issued dividends every quarter since 1944 and raised them each year for 47 consecutive years. The company generates tons of cash, which fuels perpetual dividend increases at a comfortable payout ratio of about 40%, with plenty left over for building organically and making strategic and niche acquisitions to fuel growth.
Here is the company’s record of dividends per share for the past 5 years:
2006: 1.46 (+14%)
2007: 1.62 (+11%)
2008: 1.80 (+11%)
2009: 1.93 (+7%)
The dividend increase of 7% in 2009 was J&J’s smallest increase since 1972. J&J has already declared its first quarterly dividend for 2010, holding the distribution steady with the last dividend of 2009. This conforms to its typical pattern, which is to declare a single annual increase per year with the second payment of the year.
At a recent price of $63 per share, J&J’s current dividend is 3.1%. If the company achieves the consensus growth expectations of 7% per year and matches that with equivalent dividend increases, its dividend will double in about 10 years. (To learn more about the interplay of dividend yield and growth, see my article, “10 by 10: A New Way to Look at Dividend Yield and Growth” by clicking here.)
Stock Performance and Valuation: Over the last 10 years, J&J generated a 5.1% annualized total return for investors, compared to a negative 2.5% annualized total return for the S&P 500. The stock’s average total return has beaten the S&P 500’s total return for the trailing 3-, 5-, and 10-year periods. J&J lagged the S&P 500 in total return for the trailing 1-year period, with a total return of about 14% versus the index’s total return of about twice that. This is not surprising, as large, mature stocks rarely lead a strong bull market such as we had in 2009. The upside of this one-year underperformance, of course, is that the stock now carries a more favorable relative valuation.
The stock’s valuation ratios, when blended, suggest the stock is fairly or slightly under-valued at its current price of about $63. Representative indicators include a trailing P/E of 14, Forward P/E of 13, P/CF of 12, and P/B of 4. The current P/E ratio of 14 is slightly less (i.e., better) than its recent 5-year average P/E of 16.
Investment Thesis and Conclusion: Johnson & Johnson is a solid blue-chip company with a long record of excellent performance. It is a medium-speed growth company with an exceptional record of dividend growth. J&J’s earnings growth should keep pace with the economy and inflation, and its dividend growth should outpace inflation for the foreseeable future. It deserves consideration as a core holding in any long-term investor’s portfolio. For investors following a long-term dividend-growth strategy, J&J’s current yield is fairly low at 3.1%, but the dividend could hardly be safer, and the company figures to increase the dividend by 5% to 10% or more every year.
Disclosure: Author holds a long position in JNJ.