Johnson & Johnson: What If You Bought At Current Highs?

| About: Johnson & (JNJ)
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Is the stock overvalued? Perhaps.

But will it matter much in the long-term?

Stock's floor price catches up with increasing annual dividends.

With many income stocks reaching their highs, articles like this one are all too common. We recently profiled an income favorite of ours, AT&T (NYSE:T) and projected what would happen if investors buy it at its recent highs. The article generated interesting comments, with most of the readers agreeing that a soaring price isn't enough reason to stay away from a stock as long as the long-term value remains intact.

In a similar vein, this article looks at another income favorite that has been soaring, Johnson & Johnson (NYSE:JNJ). The SA article linked above by "My Road to Half a Million" was a terrific piece arguing how JNJ is current overvalued. At a high level, we agree with that thesis that JNJ is not a bargain here. But does that mean everyone should stay away from the stock? We don't believe so and present the following points in favor of JNJ. Stocks like JNJ tend to trade at a premium generally and given the uncertainty around the Federal Reserve's rate increases, it is easy to understand why the stock appears a little stretched.

Current Situation:

  • Like many stocks, Johnson & Johnson is also trading near its 52-week highs at $108.
  • As a result, the yield right now is slightly lower than its 5-year average of 3.04%.
  • How wise is it to buy the stock now?

Income Projection:

Almost everyone owns this stock for its income. Yes, the recent capital gains are good but let's not lose sight of the fact that this is an income play. Any gains on top of it must be appreciated and not seen as a reason to sell.

Source: Yahoo Finance

JNJ's Dividend Growth Rate (DGR) has been about 7% the last few years as shown in the table below. Given the consistency, let's assume the a dividend growth rate of 6.50% for the next five years. The yield on cost will grow up to 4%. This isn't too bad considering the stability this stock brings into a portfolio, just like AT&T. Also, keep in mind that a yield level that is built up steadily is much more reliable than a high-flying yield that might not be supported properly by a company's earnings.

Earnings Projection:

JNJ reported EPS of $6.20 over the trailing twelve months (TTM), excluding special charges. Analysts are expecting earnings to grow at 5%/yr for the next five years. Being the steady player that it is, JNJ's quarterly reports almost always match the expectations and if at all there is a difference, the company surprises on the upside a little. Hence, it is reasonably safe to use the expected earnings for our projections here.

The table below shows that buying here at $108 means that the forward multiple is always in the low teens or even lower. Not a bad deal for a reliable player. Not to get repetitive but price and value are two different things. Enterprise values are best projected over the long-term and not just by looking at the current price. This task gets easier when the company's earnings are relatively stable and easy to project.

Capital Gains Projections:

Let us do this two different ways. One using the projected EPS and one using the project annual dividend per share.

  • JNJ's current multiple based on regular TTM earnings is 17.40. This is considerably lower than the market average of 21.50. Given the EPS projections in the table above, JNJ's EPS in 5 years should be around $8.31. Giving the stock the same lower than average multiple of 17.40, we arrive at a share price of $144.60. That's 33% away from where the stock is right now.
  • JNJ's increasing annual dividend also tends to create a floor for the share price at the 3% mark. Based on the 2021's expected dividend per share of $4.30, the 3% yield mark will be around $143. That's a good 33% away from the current share price. If you average the capital gains over 5 years and add the 3% yield, you get a safe 10% return per year.
  • But what makes us so confident?

    • JNJ's status as a dividend stalwart. Enough said. When a company proudly reports its dividend streak on its website, you know they take their dividends seriously. Around this time next month, investors are likely to be sitting on their 54th consecutive dividend increase.
    • Many investors make the mistake of looking at JNJ as another healthcare company. The truth is far from it. The company has at 7 different business units that each contribute at least 10% to its income. That makes the company more resilient to the usual setbacks like patent expiration and competition.
    • At the end of the day, it's all about the money. Making profits and returning the money to shareholders. JNJ's profit margin of 22% is head and shoulders above the other well known Pharmaceutical stocks like Pfizer (NYSE:PFE) and Merck (NYSE:MRK).
    • Besides everything explained above, it is hard to see this stock sell off even if the market crashes. Yes, when they raid the house, no one is safe. But most income investors still need to be invested somewhere and it's hard to see JNJ being abandoned. Will there be a haircut? Sure, there will be. That will be the time to add more. Most of JNJ's investors are in it for the increasing income, so where is the need to abandon this stock?


If a stock reaches a new high, does that make it a sell? If a stock is a little overvalued, does that make it a sell too? We don't believe so, especially if the stock is a stalwart, the multiple isn't obscene, and the reason for buying the stock still holds true. If the (unlikely) reason you bought JNJ was to make a few quick bucks, then by all means sell. If not, stay the course and collect the dividends. If you are looking at initiating a new position in JNJ, buy a little and average up or down depending on how things go. In a few years, it's hard to see that position being underwater overall.

At the end of the day, most investors will stay invested at least to keep up with inflation. If you are in fact worried about the market tipping over, what better stock to own than this healthcare conglomerate.

Disclosure: I am/we are long JNJ, T.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.