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Summary

  • Johnson & Johnson has a great long-term track record for rewarding investors.
  • Its products should benefit with current demographic trends in the developed world.
  • Johnson & Johnson has shown the ability to continuously expand sales over its recent history.

I'm not finding a whole lot of value, currently, in the U.S. stock market, at least not without going dramatically overweight beverage or energy stocks. At times like this, I have to sit back, let my cash build, and update my stock watch list. These are trying times for many value investors, as we watch global stock markets climb steadily higher. I believe patience is so critical to investing, that I wrote an article last week about the techniques I use to remain patient. While waiting, I like to analyze the stocks on my watch list and add new ones. Today, I'm going to share my thoughts on Johnson & Johnson (NYSE:JNJ).

You don't ALWAYS need to be doing something; sometimes it's best to wait.

Most investors are familiar with Johnson & Johnson, the New Jersey-based healthcare behemoth. Since its founding in 1886, Johnson & Johnson has grown to include 128,000 worldwide employees and expand around the globe. For the last 51 years, it has raised its dividend (at least annually), and has 30 consecutive years of rising adjusted earnings. The company operates in the following business segments.

  1. Consumer Products- This division manufactures and sells items like baby shampoo, skin care products, oral care products, antiseptic creams, over-the-counter supplements/medications, and feminine products. This division is responsible for many of Johnson & Johnson's best-known brands including: Motrin IB; Pepcid; Sudafed; Zyrtec; Neutrogena; Bandaid; and Tylenol.

  2. Pharmaceuticals- This division sells various products to healthcare providers, retailers, and distributors for prescription use. These products involve treatments for various blood, heart, neurological, and metabolic diseases.

  3. Medical Devices and Diagnostics- This division sells its products to doctors and healthcare facilities (clinics and hospitals). Think of replacement joints, pacemakers, and heart catheters when you think of this division.

With that background in mind, let's take a deeper look at Johnson & Johnson. Based on a recent stock price in the $92-$93 per share range, the company boasts a dividend yield of 2.9% and a PE (price-to-earnings) multiple of about 19. Shares currently trade at about 3 times book value. Additionally, the company has more cash and cash equivalents ($29+ billion) than debt ($18+ billion). A well-capitalized company with a rock solid balance sheet is better able to ride out short-term struggles, and should therefore be a more stable investment.

I always like to see consistent revenue growth (on a per share basis) from the companies I invest in. With that in mind, check out this chart of JNJ's revenue growth over the past 10 years.

Johnson & Johnson's operating income and net income both increased in FY2013, to $18.4 billion and $13.8 billion respectively. Johnson & Johnson has a long history of steadily raising dividends and buying back shares to reward shareholders. Below is a chart of the most recent 10 years of dividend raises. It is likely that these dividend increases will continue into the future, given the current 54% payout ratio.

Important Metrics

Return on equity (ROE) - Although more recently, Johnson & Johnson's ROE has been on the low end of the range, it has a long history of strong ROE figures. For the last 10 years, those figures have ranged from 16.7 to 30.5.

Operating Margins - Operating margins at Johnson & Johnson have been holding steady for the past 10 years, in the mid 20% area. For a company of its size and with its array of products, I think such consistent profit margins are a great sign.

Price-to-Discounted (projected) Cash Flow - According to GuruFocus.com, Johnson & Johnson's stock price dividend by its projected future earns comes in at 1.5. This is toward the lower end of the company's historical range (0.87 to 6.06).

Conclusions

As mentioned above, Johnson & Johnson has a long history of rewarding shareholders with stock buybacks and increasing dividends. The company has spent big money on repurchasing stock each of the past 10 years, including nearly $13-billion worth in 2012. Given the developed world's aging demographic and declining health, I think healthcare companies like Johnson & Johnson are a great place to invest for the future. I have been a shareholder since 2008, and my only complaint is that I didn't buy more shares in 2008. Yes, I know that's a common complaint in hindsight.

(click to enlarge)

Still, it can take years for Mr. Market to reward shareholders of a given company. Look at the Yahoo Finance chart above of how the company's shares have traded over the past 15 years. Throughout the past 15 years, Johnson & Johnson was growing and profiting, but investors that bought the stock in 1999 (at $50) still had a stock trading at $50 in 2009. I recognize that those were two very different years, but I want to reinforce the idea that investors need to be patient for years while waiting for higher prices. Dividend investing helps me be patient and wait for stock markets to recognize what I believe to be quality investments.

For my portfolio, Johnson & Johnson has the right mix of long-term growth and a management that is rewarding shareholders. It also has one of the strongest balance sheets in the S&P 500, which limits the company's downside risk. With all of my bullish comments and the metrics listed above, you may be wondering why I'm not adding to my shares at these levels. My answer is simple, I believe the broad stock market is overvalued. Whether it is my "mean reverting" tendencies, Professor Shiller's CAPE metric, or artificially low interest rates, I just don't see Johnson & Johnson shares as a compelling investment at these levels. Look at the Morningstar.com valuation table below. The company's shares are even trading at a premium by their own historical standards.


Courtesy of Morningstar.com

As for Johnson & Johnson, technically, I believe it may have put in a short-term top in the $93-$95 area. Furthermore, I believe many income investors purchased shares of companies like Johnson & Johnson specifically because U.S. government bond yields are/were so low. I anticipate many of these investors will sell their shares and rotate back into bonds when bond yields eventually rise. Therefore, I see significant headwinds for the stock price, while the underlying company continues to thrive. Barring a significant reduction in share price to at least $80, I will watch JNJ and reevaluate it in 3 months. I am not a buyer at these levels.

Disclosure:

I am long JNJ. This article is for informational purposes only and should not be considered a recommendation for anyone to buy, sell, or hold any equities. I am not a financial professional. The information above is provided by Johnson & Johnson's website, Morningstar.com, Yahoo Finance, and GuruFocus.com.

Source: Why Johnson & Johnson Is On My Watch List