Johnson & Johnson (JNJ) is one of the premier blue-chip companies in the world. It is one of only four AAA rated corporations with headquarters in a country with a AA rated government. For much of the past two decades, Mr. Market has traditionally applied a premium valuation to this high-quality enterprise. However, Johnson & Johnson's stock price began reverting to its mean earnings justified valuation in the spring of 2005. Then, following this initial shift in valuation reconciliation, the great recession of 2008 drove the stock price into undervalued territory. Since that time, Johnson & Johnson's stock price has been tracking earnings but at an undervalued level.
Although Johnson & Johnson's earnings growth did slow down, it nevertheless increased earnings every year right through and including during the great recession. Johnson & Johnson is a Dividend Champion that has increased the dividend every year for 49 consecutive years. Consequently, we believe that Johnson & Johnson represents a very conservative opportunity with a current dividend yield that is higher than the interest available from the 30-year Treasury bond. Moreover, Johnson & Johnson offers the opportunity for continued dividend growth and the opportunity for above-average capital appreciation resulting from future growth and a strong possibility of future price-earnings-ratio expansion.
With interest rates hovering near all-time lows, investors needing income are faced with very limited choices. The traditional high yield available from bonds and other fixed income vehicles is no longer available to meet the goals of retirees needing income to live off. Moreover, it is almost a certainty that today's low yields are not adequate enough to fight inflation. Consequently, there is a growing investor interest in dividend paying common stocks, especially those that have a long record of increasing their dividend every year.
Growth and dividend income stocks are defined as companies that provide the opportunity for long-term capital appreciation and a growing dividend income stream over time. Both, capital appreciation and dividend growth will generally be consistent with the company's average earnings growth, assuming there is a strict adherence to sound valuation.
Johnson & Johnson: Large-cap Growth at an Attractive Price
Taken directly from Johnson & Johnson Website
Caring for the world, one person at a time…inspires and unites the people of Johnson & Johnson. We embrace research and science - bringing innovative ideas, products and services to advance the health and well-being of people. Our 118,000 employees at more than 250 Johnson & Johnson operating companies work with partners in health care to touch the lives of over a billion people every day, throughout the world.
Earnings Determine Market Price: The following earnings and price correlated F.A.S.T. Graphs™ clearly illustrates the importance of earnings. The Earnings Growth Rate Line or True Worth™ Line (orange line with white triangles) is correlated with the historical stock price line. On graph after graph the lines will move in tandem. If the stock price strays away from the earnings line (over or under), inevitably it will come back to earnings.
Johnson & Johnson: Historical Earnings, Price, Dividends and Normal PE Since 1993
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Performance Table Johnson & Johnson
The associated performance results with the earnings and price correlated graph, validates the above discussion regarding the two components of total return, capital appreciation and dividend income. Dividends are included in the total return calculation and are assumed paid, but not reinvested.
When presented separately like this, the additional rate of return a dividend paying stock produces for shareholders becomes undeniably evident. In addition to the 8.9% capital appreciation, long-term shareholders of Johnson & Johnson would have received an additional $152,459.44 in dividends that increased their total return from 8.9% to 10.4% per annum.
The following graph plots the historically normal PE ratio (the dark blue line) correlated with 10-year Treasury note interest. Notice that the current price earnings ratio on this quality company is as low as it has been since 1993.
A further indication of valuation can be seen by examining a company's current price-to-sales ratio relative to its historical price-to-sales ratio. The current price-to-sales ratio for Johnson & Johnson is 2.72, which is historically low.
Looking to the Future
Extensive research has provided a preponderance of conclusive evidence that future long-term returns are a function of two critical determinants:
- The rate of change (growth rate) of the company's earnings
- The price or valuation you pay to buy those earnings
Forecasting future earnings growth, bought at sound valuations, is the key to safe, sound, and profitable performance.
Therefore, it logically follows that measuring performance without simultaneously measuring valuation is a job half done. Johnson & Johnson is clearly an industry leading superior business, which based on the consensus estimates from leading analysts, appears to be capable of growing earnings at an above-average rate for the foreseeable future. At its current price, which is attractively aligned with its True Worth™ valuation, Johnson & Johnson represents an opportunity for growth at a reasonable price. The important factor is that Johnson & Johnson, with its strong balance sheet and potential for future earnings growth, has real assets and cash flow underpinning its stock price. This solid economic foundation offers shareholders the potential for both a strong margin of safety and an opportunity for outsized future returns.
The Estimated Earnings and Return Calculator Tool is a simple yet powerful resource that empowers the user to calculate and run various investing scenarios that generate precise rate of return potentialities. Thinking the investment through to its logical conclusion is an important component toward making sound and prudent commonsense investing decisions.
The consensus of 23 leading analysts reporting to Capital IQ forecast Johnson & Johnson's long-term earnings growth at 6.5%. Johnson & Johnson has low long-term debt at 14% of capital. Johnson & Johnson is currently trading at a P/E of 12.9, which is inside the value corridor (defined by the five orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, Johnson & Johnson's True Worth™ valuation would be $105.36 at the end of 2017, which would be a 11.4% annual rate of return from the current price.
Earnings Yield Estimates
Discounted Future Cash Flows: All companies derive their value from the future cash flows (earnings) they are capable of generating for their stake holders over time. Therefore, because Earnings Determine Market Price in the long run, we expect the future earnings of a company to justify the price we pay.
Since all investments potentially compete with all other investments, it is useful to compare investing in any perspective company to that of a comparable investment in low-risk Treasury bonds. Comparing an investment in Johnson & Johnson to an equal investment in 10-year Treasury bonds, illustrates that Johnson & Johnson's expected earnings would be 5.4 times that of the 10-Year T-Bond Interest. (See EYE chart below). This is the essence of the importance of proper valuation as a critical investing component.
Summary & Conclusions
This report presented essential "fundamentals at a glance" illustrating the past and present valuation based on earnings achievements as reported. Future forecasts for earnings growth are based on the consensus of leading analysts. Although, with just a quick glance you can know a lot about the company, it's imperative that the reader conducts his or her own due diligence in order to validate whether the consensus estimates seem reasonable or not.
After being fully traumatized by the great recession of 2008 and the subsequent above-average market price volatility, investors have been fleeing equities at unprecedented levels in order to seek safety. Yet ironically, Johnson & Johnson arguably represents one of the safest securities for prudent investors to consider. In addition to its strong financial condition, we believe that today's low price mitigates risk at a greater level than has historically been available from investing in this high-quality blue-chip. Perhaps Warren Buffett was thinking about Johnson & Johnson when he said: "be fearful when others are greedy, and greedy when others are fearful." With fear running rampant today, Johnson & Johnson looks like a quality dividend growth stock worthy of being greedy about.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
Disclosure: I am long JNJ.