Johnson & Johnson: A Defensive, Less Volatile Investment Option

Investors looking for a defensive play should consider Johnson & Johnson (JNJ), the global health care leader with exposure to growing baby boomer demographics and reliable customers like medicare and medical. The company is a floating battleship in this unstable market environment. With a market cap north of $190bn and footnote proportionate debt of only $1.3bn, it boasts a quarterly free cash flow @ $3bn.

Income from its more than 250 operating companies is fairly diversified with 53% coming from the U.S. and the other 47% spread amongst 75 countries. International income is derived from Europe, Japan and emerging markets e.g. Russia, China, India, Latin America. Business is divided into 3 segments: consumer products (23.7%), pharmaceuticals (40.7%), and medical devices and diagnostics (35.6%).

Financial analysis: If this is not enough, then JNJ pays its patient investors $1.84 cash per share or 2.8% annually. Do not worry. The dividend is safe with a conservative payout ratio of 42%. Besides, management is also very effective by delivering ROE @ 26.46%.

 JNJ is truly the best of its breed. It leads drug manufacturer peers in terms of market capitalziation and superior sales (8.22% vs. 7.7% industry),  income (22.5% vs. 17.1% industry), and net profit margins (18.6% vs.18.1% industry).

Valuation analysis: Due to it superior growth rates, JNJ earns the right to trade at a premium 16.2 PE vs. the industry average 15.2 PE. If so, then FY2008 projected EPS of $4.52 makes it worth @ 73.22 per share while FY2008 projected EPS of $4.74 gives it a value @ 76.80 per share. JNJ believes that it can deliver these earnings results by improving its margins and share buybacks scheduled for FY2009.

Acquisition strategy: A buy at or below its 200 day moving average support @ 66.59 would be ideal. Resistance is @ 50 day moving average @ 70.08.

Try writing the Nov 65 puts and buying the Nov 60 puts for a bull credit put spread @ 1.00. Because the option trade is covered, margins requirements of $5 translates into a 20% return if JNJ stays above 65 while the investor’s break even is 64. If things really turn bad during the November options expiration period, the maximum downside is -6.25% with insurance protection from the November 60 put.

However, one really wants to acquire this great company and if the stock gets assigned, a cost basis of 64 throws off a dividend yield of 2.88% and an earnings yield of 7.4% based on 2009 estimates. If the stock trades between 73 and 76 per share, the upside potential is @ 14% to 19%. Should bearish market conditons persists, investors may also consider writing collars or covered calls to reduce their volatilty.

Comments

[User 223064:]

Can you explain your options acquisition strategy again? Thanks

2008 Oct 02 03:05 AM

[nelsb@centu...:]

Thank God I have owned J & J since the Tylenol scare. It is the cornerstone of my portfolios and has done really well for me.

2008 Oct 02 12:05 PM

[nelsb@centu...:]

I thank God for the good fortune of owning J & J since the Tylenol scare. It is the cornerstone of my portfolio.

2008 Oct 02 12:07 PM