Johnson & Johnson Profit-Taking Likely, Offering Better Entry Point

Shares of Johnson & Johnson (JNJ) quietly reached a new 52-week high Friday. This caught our attention, since it at once seemed out of the ordinary, but somewhat comforting, as the recent economic weakness has likely pushed portfolio managers to add to defensive stocks like JNJ, whose vast panorama of business lines likely strips away most of the idiosyncratic risk they would have to take on (assuming no proper hedging) if they invested in a smaller company that was not as diversified and reputable as JNJ.

Nevertheless, we ran some numbers, and ignoring, for the time being, Johnson and Johnson’s fundamentals, we noticed that over the last 3 months, JNJ and the Dow Jones have gone in diametrically different directions. The Dow is down 8% over the last 90 days, whilst JNJ, which is one of the Dow 30 components, is up 8%

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We would be amiss in recommending a short on JNJ here, but we find it noteworthy enough to point out and if you are a portfolio manager with a position in JNJ, it may not hurt to trim profits and/or review your holdings with your analyst team. We found that over the last 5 years, JNJ’s monthly returns have been most likely in the -2 to 0% range.

As one can see from the frequency diagram, there have been plenty of instances in which JNJ has had monthly returns in excess of 2% and 4%. That may very well continue and we may be completely wrong in throwing rain on JNJs parade. However, we would argue that over the last 5 years, JNJ was facing a much more benign environment that it currently faces. Today, JNJ’s current patent loss headwinds (high margin drugs Risperdal and Topomax) and a challenging stent landscape have heightened JNJ risk profile, we would argue. Furthermore, JNJ’s Q2 top line growth was driven mostly by (64% of the 8.7% growth, to be exact) favorable foreign exchange rates and Wall Street simply may have gotten ahead of itself in bidding up shares.

JNJ clearly isn’t going to disappear anytime soon. On the contrary, JNJ’s mountain of free cash flow makes us longtime fans of the stock – it’s just that given the statistical backdrop outlined above, we expect some profit taking soon and can likely get JNJ at a better price. If you remember nothing else: great companies don’t always translate to great stocks.

Disclosure: None

Comments

[udirtyrat:]

The question is...What better price? Just because what happened in the past doesn't necessarily mean the future is foretold. Energy is dead, for now, financials are stable but unsure and tech is a wash. You got anywhere else that's this safe? I didn't think so.
You could argue that for the last 5 years everyone was on the oil bandwagon or "short" run that JNJ wasn't on anyone's screen. JNJ is probably the best run company in the entire market. The cash flow is HALF of their outstanding debt and if they use just a bit of that to rid itself of that overhang, what little it is, then the stock will be another 10% higher from these highs. Nope...your argument is off base and this is where the price should be.

2008 Aug 11 11:27 AM

[Dan Jacome:]

Thank you for your comment -- we do not disagree that JNJ is a solid company with a cash flow spigot that could easily be used to reduce int exp, and thus free up more earnings power. However, we simply wanted to note -- or suggest, better -- that investors may be jumping aggressively into JNJ because of short term uncertainties with the market as a whole. This will likely continue (PMs pushing their analysts to focus on more stable cash flow companies, more recession proof names), but in the long term, which the Street's risk appetite improves, JNJ will see a pullback. Whether that is next quarter (unlikely) or in 2009 (likelier), no one knows.

Put in a larger perspective: JNJ has outperformed the Dow over the last 30 years. It has approximately moved in tandem with the DJIA over the last 5Y. Over the last 2Y, it has underperformed the Dow. In the last 3 quarters roughly, JNJ has outperformed the Dow by a wide extent (we use 07 as a marker of "credit crisis begins")...

All we wanted to "throw out there" is that those holding onto JNJ may want to look at their holdings a tad closer and determine if JNJ's run up is fully warranted by its fundamentals. Clearly, our work is the first tiny step (a sprinkle of evidence) in a much larger JNJ project, which may or may not ultimately corroborate what we we found.

2008 Aug 11 03:57 PM

[GregT:]

Good analysis. JNJ has many characteristics common with both health care stocks and consumer staples stocks like PG and PEP. The recent runup and 52 week high coincides with runups for both of these categories and is not specific to JNJ alone.

The bullish argument for JNJ is that even at the current price of 71, it is a pretty good value. The bearish argument is that growth is not what it used to be as the company has gotten larger. It would take quite a catalyst to give JNJ any kind of significant boost.

Most likely JNJ's stock price will grow at the same rate as it's EPS over the next 5 years unless something unusual happens. With the uncertainities for both the markets and economy, JNJ represents a safe have that should provide stability to a portfolio.

2008 Aug 14 07:36 AM

[Dan Jacome:]

Thanks, User242720!!

2008 Aug 14 01:01 PM