Johnson & Johnson (JNJ) happens to be one of my favorite stocks. However, based on the current economic environment and recent trading trends, income investors may want to consider rotating out of it and into a higher-growth, yet lower-dividend, name like Qualcomm (QCOM).
Before I discuss my research, I want to make sure readers are aware that I am in the camp of immediate income and homegrown dividends. This article isn't designed to persuade long-term buy-and-hold investors who seek dividend growth to change their strategy. Instead, consider it a trade idea for more active investors who don't mind harvesting a gain or repositioning assets based on macroeconomic trends, which may offer greater future capital appreciation in conjunction with some base income.
Essentially, my contention is that JNJ is currently fully valued near $68 a share. It recently hit a new 52-week high of $68.15 after trading as low as $61.78 on June 1, 2012. That's nearly a 9% gain, or more than 2.4 times its annual dividend, in less than 45 days.
Our buy price for JNJ initiates below $63, and while Morningstar and Yahoo Finance both have fair value targets in the low to high $70s, we feel the current economic climate reduces its prospects of any comparable future gains. That's primarily because we think the next big catalyst for the market will be some form of QE3.
As our table illustrates below, the Federal Reserve's quantitative easing measures have had a diminishing affect on individual stocks as well as the broader markets. For example, QE1 produced a return for the Dow of nearly 28.5% while QE2 offered 12.6%, and Operation Twist lifted the markets by 11.8%. Similarly, both JNJ and QCOM saw diminishing returns over the same time periods.
Yet after reviewing both QE1 and, more specifically, QE2 trends for both names, JNJ may not be the best place for income-oriented investors to be if/when QE3 begins. For example, JNJ was trading at $60 a share when QE2 began on Nov. 3, 2010. For the next five months it traded between $55 and $59, finally breaking out above $60 on April 20. That was a very slow start to what many would consider a bullish sign for stocks. However, from the April 20 breakout, JNJ ultimately gave way to a respectable 6.5% gain ($64 a share) when QE2 ended on June 30, 2011.
On the other hand, a higher beta/lower dividend payer such as QCOM saw a significantly larger returns during both phases of the Federal Reserve's intervention. Once again, focusing on QE2, QCOM shares began the period at $44.47 and essentially headed straight up, braking in the $50s in early January and finally giving way to a 25% gain ($55.88 per share).
QE Analysis Table
Company | Ticker | Current $ | Curr. Yield % | Beta | QE1 Return | QE2 Return |
Johnson & Johnson | JNJ | $67.88 | 3.60% | 0.55 | 14.87% | 6.39% |
Qualcomm | QCOM | $55.08 | 1.84% | 0.99 | 31.11% | 25.66% |
Calculated as holding period returns based on yahoo historical prices and for illustrative purposes only | ||||||
QE Source: Bankrate.com QE1: Nov 24, 2008 - March 31, 2010: QE2 Nov 3, 2010 - June 30, 2011 | ||||||
From a valuation perspective, JNJ is trading at a forward P/E of 12.2, while QCOM below $55 a share sits at a favorable 13.3, especially considering its most recent revenue numbers. QCOM turned out an impressive 36% increase in revenue for 2011 and is expected to close out 2012 above 30% once again. JNJ, on the other hand, does offer investors twice as much dividend yield, but with revenue growth expected closer to 5%, income-oriented investors may want to consider trading off lower portfolio yield for future growth (and income) through capital appreciation.
Considering the fact that the Fed's most recent minutes did not hint at any immediate easing, my sense is that other possible catalysts -- such as improving economic data in China, the eurozone stabilizing, or second-quarter corporate earnings coming in better than expected -- are as likely to spur a risk on trade as QE3 would. Therefore, I suspect that whether it's the stagnant job picture that ultimately forces QE3 or one of the other catalysts coming to fruition, a "risk on" trade could push the price of JNJ below both its 50- and 200-day moving averages of $65 while conversely sending QCOM back above $60. That's a possible 8% gain on QCOM as compared to a possible 4.5% loss on JNJ based on the aforementioned factors.
In summary, I believe that income-oriented investors who want to position their portfolios for maximum capital appreciation with a suitable income base may want to consider a sector rotation like this, based on the current economic environment and trading patterns of JNJ and QCOM.
Disclosure: I am long JNJ. Long JNJ for some clients based on tax issues.
