Will Buffett Dump Johnson & Johnson?

| About: Johnson & (JNJ)

A couple days ago Warren Buffett signaled that he might consider selling his Johnson & Johnson (NYSE:JNJ) shares if he needs cash for other investments. In another development, the company announced that its CEO of ten years, Mr. Weldon would resign and be replaced by the vice president Alex Gorsky, a West Point graduate. In its 126 year history, the company had only 8 CEOs so far, making each CEO change very significant news for the company. Now all eyes will be on Mr. Gorsky and he might not have much time to accomplish a turnaround as investors tend to have low patience in general. The departing CEO will get a bonus of $3.1 million for his 2011 performance, which indicates a raise of 55% compared to 2010.

As a cultural thing, Johnson & Johnson always picks its CEOs from within. Mr. Gorsky has been with the company for about 24 years except for a gap between 2006 and 2010. He started as a sales representative and worked his way up all the way to CEO position. He is known to take conservative approach on things and he is not expected to change too much in the company for now. On the other hand, Mr. Gorsky is said to have much better communication with the board of directors than Mr. Waldon, which should be a huge advantage.

Mr. Gorsky has been examining the quality and safety issues at JNJ for a couple years now. He is more knowledgeable about the issue than many others, and hopefully he will come up with a solution. Johnson and Johnson got in trouble with Food and Drug Administration when the company started to recall a large number of drugs it produced. Recently the company had to recall 574,000 bottles of Tylenol as there were issues surrounding the dosage. As a result, the quality and safety of JNJ products came into attention.

As the company's brand image started to suffer, another hit came from competition as Teva Pharmaceuticals (NASDAQ:TEVA) and Procter & Gamble (NYSE:PG) entered into a partnership to sell over-the-counter drugs last spring. Because JNJ's patents for many of its OTC drugs have already expired, the company lost major market share in the last couple years. The company also suffered from having to recall a large number of artificial hip implants as well as Motrin and Benadryl brands it produces. The US Health Department ended up taking temporary control of 3 production plants that belong to JNJ as a result of these massive recalls.

The company faces many lawsuits for its defected products and it will have to set aside a large sum of money for those lawsuits. In addition, the recalled artificial hip implants will cost the company another $3 billion. The former CEO, Mr. Walden had to address the congress in 2010 about the recalls and other issues faced by the company.

It's not all bad news for the company, however. JNJ's joint venture with Bayer (OTCPK:BAYRY) to produce blood thinner Xarelto looks very promising. Xarelto is designed to help patients with acute coronary syndrome. Bayer published some data suggesting that the drug was successful at reducing risk of heart attacks, strokes and deaths related to cardiovascular dysfunctions by 30%. Currently, the drug is on its path to get FDA approval. Recently, FDA granted Xarelto priority review, making it possible for it to gain approval sooner than originally planned.

JNJ plans to purchase Synthes, a Swiss medical device company. Synthes produces implants and biomaterials used in surgeries. This acquisition, when finalized, will add a lot of promising products to the company's portfolio. JNJ will have to pay $21 billion for purchase of this company, which will be its largest purchase ever.

Despite all the problems and issues, most investors did not lose faith with the company. JNJ's very strong history of dividend growth played a role in investor loyalty to this company. In the last year, the company's stock price is up by about 6%. JNJ's current dividend yield is 3.5%. This year marks the 49th year in a row that JNJ raised its dividends. In average, JNJ increased its dividends by almost 10% every year.

Warren Buffett's company Berkshire owns 1.2% of JNJ at the moment. This translates into over 34 million shares of the company. Buffett still believes that JNJ is a sound business with good valuation; however he also believes that the company made a lot of mistakes in the recent years. Time will tell if he will keep his JNJ shares or not. Buffett loves companies with nice valuation. JNJ's P/E ratio of 18 and its price to book value ratio of 3.12 are near the company's all time lows. In the 2 charts below, you will see the company's P/E and P/Book values in the last decade.

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With this in mind, I believe Mr. Buffett will give JNJ another chance. After all, Warren Buffett is much more patient than an average investor who sells many shares at the first sign of panic.

The implications of this for other investors are as follows. First of all, I don't believe a company as large as JNJ is going away anytime soon. In its 126 years, the company had many ups and downs and the company will definitely survive through this. Second, dividend investors have nothing to worry about as the company is committed to dividend growth evidenced by its past. Third, growth investors should wait on the sidelines until the company fixes its image. Those who already own the stock don't need to sell it, but they might want to wait before clouds clear before increasing their position. The company still continues to make money and it continues to grow at an annual rate of 7%. This is still a good bet.

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