Johnson & Johnson (JNJ) engages in the R&D, manufacture and sale of a broad range of products in the healthcare field. It is a holding company, which has more than 250 operating companies conducting business in virtually all countries of the world. It is organized into three business segments: Consumer, Pharmaceutical and Medical Devices and Diagnostics.
There are very few companies that can compete with Johnson & Johnson when it comes to consistently paying a dividend, as well as consistently increasing that dividend over time. The company managed to provide double-digit increases in the dividend, even going into the Great Recession, and continued to increase its dividend in the years that followed, despite a slow recovery.
Included below are Johnson & Johnson's historical dividends for the past decade:
| Year | Dividend | Dividend Growth |
| 2002 | $0.80 | -- |
| 2003 | $0.92 | 15% |
| 2004 | $1.1 | 20% |
| 2005 | $1.28 | 16% |
| 2006 | $1.46 | 14% |
| 2007 | $1.62 | 11% |
| 2008 | $1.8 | 11% |
| 2009 | $1.93 | 7% |
| 2010 | $2.11 | 9% |
| 2011 | $2.25 | 7% |
And the trend is obviously still intact, given the 7% increase in the quarterly dividend rate that was recently approved by the Board of Directors. Furthermore, JNJ has also been able to provide the fuel for this growth by increasing its free cash flow per share, rather than simply expanding its payout ratio.
I would expect a company as mature as JNJ to have a much higher payout ratio compared to a (relatively) "newbie" dividend payer, such as Microsoft (MSFT). But with a payout ratio in the mid-thirties, JNJ will likely be able to continue increasing its dividend through a combination of increased FCF and payout ratio expansion.
| Year | FCF/Share | Payout Ratio (Div/FCF per share) |
| 2002 | $2.85 | 28% |
| 2003 | $3.36 | 27% |
| 2004 | $3.84 | 29% |
| 2005 | $4.25 | 30% |
| 2006 | $4.6 | 32% |
| 2007 | $5.23 | 31% |
| 2008 | $5.70 | 32% |
| 2009 | $5.69 | 34% |
| 2010 | $5.92 | 36% |
| 2011 | $6.25 | 36% |
Dividend Discount Model
In performing this valuation, I made several assumptions. First, I used 9% as my discount rate, based on the long-term average return of the stock market. Second, I used JNJ's 7% dividend increase to set the dividend growth rate for 2012 ($2.44/share). I used a constant growth rate of 9% for years 2013-17, and a 7% growth rate for 2018-22. Finally, I assumed a 5% perpetuity rate after 2021.
Based on these assumptions, I calculated that JNJ's intrinsic value is $82 per share. At the current price of $62.34/share, the stock is ~24% below its intrinsic value and provides an incredibly large margin of safety, especially considering the company's long track record, diverse revenue streams and global franchise.
Another interesting way to look at the company, is to ask what constant growth rate does the market think JNJ will achieve? At the current price, the market is assuming that JNJ will grow its dividend at just over 5% a year. I believe this is way too low an estimate, given the pricing power and the track record the company has in using capital effectively.
Either way you look at it, Johnson & Johnson is undervalued and offers a very large margin of safety at its current price. Therefore, long-term, income-oriented investors may want to give JNJ a closer look to see if it should be included in their portfolio.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in JNJ over the next 72 hours.
Additional disclosure: 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. 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.
