Investors searching through the vast array of investment ideas in the market would do well to limit their search to companies with solid earnings and a consistent growth history. One stock worth serious consideration is Johnson & Johnson (JNJ), a blue chip company with a track record dating back more than century. Much more than just a consumer products company, J&J has built itself into a multinational enterprise made up of a diverse collection of business units.
We're all familiar with the ubiquitous J&J products like Band-Aid, Q-Tip and Tylenol, to name just a few. But it also owns such premium brands as Aveeno, Neutrogena, Neosporin, Motrin and Sudafed, among others. In addition to its consumer brands segment, J&J has a pharmaceutical division that holds patents on many of the best-selling drugs on the market and a medical devices and diagnostics division. In each of the segments J&J competes, the company is committed to being the top tier player in the market.
As an enterprise, J&J is actually a collection of operating companies that collectively comprise the whole, but that are managed by independent teams reporting to the corporate . The company competes with the likes of Proctor & Gamble (PG) in the consumer segment, Abbott Laboratories (ABT) and Novartis (NVS) on the pharmaceutical side, and Bristol-Myers Squibb (BMY) in medical devices.
Given its diverse product mix, premium brand image and strong consumer loyalty, you would expect J&J stock to command a high earnings multiple. In fact, when measured against its peers, this company compares favorably. And with one of the highest dividend payouts among competitors, J&J is an attractive investment in a reasonably safe segment of the market.
Although the past decade has been essentially flat for the stock, there are events on the horizon which I believe will lead to significant share price increases in the coming year. J&J has always been an acquisitive company, buying proven businesses that fit into its overall growth plans. The recently announced purchase of Swiss-based Synthes will close early this year, and will make J&J the world's largest orthopedic device company. This acquisition is the largest in the company's history, and is being completed at a time when borrowing costs are at historic lows and the valuation of the target company is very reasonable.
This type of transaction is typical for the company, and will result in nearly $4 billion of increased revenue immediately. As with other recent acquisitions, the company's goal is to grow sales and revenue, while maintaining its core market dominance. This philosophy has resulted in a higher concentration of growth in the higher margin medical device and pharmaceutical divisions, creating a higher return on invested capital. The current mix of businesses is; Medical Devices and Diagnostics (40% of revenue), Pharmaceuticals (36%), and Consumer Products (24%). This conscious shift toward more profitability is sure to continue in upcoming acquisitions.
In addition, the company has a history of increasing its dividend payout for the past 49 years in a row. At a recent share price of around $65, the yield currently sits at 3.5%. With Treasury rates at historic lows and investors looking everywhere for returns, a company like J&J is very attractive to dividend seekers. When you add in the nearly $33 billion in cash and short-term investments, the company will likely increase its dividend by a significant amount this year, making it even more attractive.
One final catalyst for movement may just be the stock's recent share price performance, or lack thereof. Having gone essentially nowhere for the past ten years, many of the company's investors and institutional holders are beginning to lose patience with the management team. When this happens, often a company with J&J's cash hoard will unlock value in the form of stock buybacks, special dividends and further accretive acquisitions. Any of which will drive the stock price higher.
The company does face some challenges in the near term as well. Patent expiration on two of its biggest drugs will put pressure on 2012 earnings and comps. Also, recent product recalls of some of its consumer products as well as some medical devices will put pressure on not only earnings, but the stellar reputation of the company. Intangible hits against a company like this are difficult to quantify, but still must be factored in as a greater than zero effect.
In addition, healthcare restructuring in the US, as well as other developed countries is likely to put pressure on all pharmaceutical and medical device manufacturers. J&J is perhaps more protected than some of its competitors due to the buffer of consumer products, but there is some risk. Finally, in recent years, J&J's growth rate has faltered a bit, giving it a forward PEG ratio of nearly 2.1. This may not be a huge concern if growth returns to normalized rates, but the law of large numbers applies, even to a company like J&J.
The Bottom Line
As a diverse healthcare company, J&J is relatively protected from sharp downturns in the economy. In fact, the company's .48 beta rating means that it has less than half the volatility of the overall market. And there aren't many companies that are managed as conservatively as this one. With revenue continuing to grow every year and dividends increasing for the past 49 years running, this is obviously a fiscally healthy company.
With 2012 full year earnings expected to be around $5.11 per share, the company has a reasonable forward P/E of around 13. This is historically low and leaves plenty of room for expansion. As investors catch on to the increase in revenue and sales growth, the current projections will seem too conservative. Applying an historic P/E multiple of around 18 yields a stock price closer to $78 per share than the current $65.
I believe patient investors, as well as those wishing to cash in on a decent dividend yield, would do well to consider adding J&J stock to their portfolio. As a conservative investment, being run by a seasoned and shareholder friendly management team, very few companies can compare to the value and safety of J&J.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.