Johnson & Johnson (NYSE:JNJ) is a perfect example of why serious investors must always conduct their own in-depth research rather than relying simply on the word of others.
At first glance, J&J looks expensive. Go to Google Finance, Yahoo Finance, or a similar website. You'll see that the quoted P/E is 21.73 and that the quoted EPS is $3.14. Dividend growth investors looking to pick up stocks "on sale" might immediately cross J&J off their list. But doing so would be shortsighted.
Take a look at the following chart. Notice the huge divergence in free cash flow and net income over the past few years.
The situation at J&J is similar to what Microsoft (NASDAQ:MSFT) just experienced when they reported a first-ever loss. The loss at Microsoft was due to a write-down and is, if you will, only existent "on paper." Free cash flow is still very strong. Thus, the quoted P/E data for Microsoft is essentially useless.
The same thing happened at J&J, just on a broader scale. Free cash flow shows that J&J is still just as strong as ever. However, J&J has had a string of lawsuits over antipsychotic Risperdal as well as recalls on hip implants and Motrin. In Q4 2011 alone, J&J took a $3 billion charge on these matters. This has led to TTM EPS falling from nearly $5 to $3.15.
But in reality, since free cash flow is as strong as ever and the litigation and recalls were one-time incidents, investors should consider J&J's "true" EPS to be higher. Using a figure of $4.50 for EPS, J&J's P/E falls to 15.1, which is in line with the broader market and honestly somewhat of a discount for such a high quality, consistent company. Using a figure of $4.75 for EPS would yield a P/E of 14.3, and using 2013 mean analyst EPS of $5.46, J&J trades at a pretty cheap forward multiple of 12-ish.
Given J&J's strong dividend history and fairly inexpensive adjusted valuation, investors should be happy to pick up shares of such a quality company at a P/E below any period since '95, with the brief exception of the post-financial-crisis sell off.
Key takeaway: J&J isn't expensive. Ignore the quoted valuation, because it doesn't paint the full picture. Excepting the occurrence of a black swan event, now is as good a time as any to pick up some J&J shares.