Johnson & Johnson Is Offering A Fair Deal

| About: Johnson & (JNJ)
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Johnson & Johnson traded in the $60s for quite some time, but has moved materially higher in the last few years.

This article offers the reminder that a higher price can still provide a reasonable investment.

While you may not be interested in buying shares today, this sort of recap can keep the security on your radar for the future.

One of the things that can be difficult for an investor to overcome is anchoring yourself to past prices. For instance, by knowing that AT&T (NYSE:T) exchanged hands below $32 less than eight months ago, suddenly this makes a price near $39 less attractive. Or seeing Franklin Resources (NYSE:BEN) at $40 isn't as impressive given that you could have purchased shares in the low-$30s earlier this year.

Like consumers, a lot of investors like "sales." Yet here's the thing: there are a couple of items to consider before we get permanently anchored to a given price. First, it's quite unlikely that you're going to consistently "catch the bottom." So while you might have a low number in mind, you might not get that opportunity to actually do something about it (for a number of reasons ranging from timing and attention to having the capital on hand when an opportunity is presented).

Just as important is the idea that profitable businesses tend to get more profitable over time. In turn, the dividend payments tend to increase as well. So a higher and higher price, while unfortunate in an anchoring sense, could be offering the same type of value proposition. A company that now makes 10% more and pays out 10% more can be just as attractive on an ongoing basis as it was before.

Personally, this is something that I have to remind myself of when I think about a security like Johnson & Johnson (NYSE:JNJ). I last purchased shares in the $60s, and for a long time I've had that price anchor in place. Naturally, this share price is possible in the future, but it gets less and less likely as the company earns more and pays out more in dividends. Given that you don't often see exceptional businesses trading under 10 times earnings or with a 5% dividend yield, eventually the share price gravitates higher. Not linearly, not absolutely, but given enough time a more profitable business is generally reflected with a higher share price.

With that thought in mind, I find it useful to "readjust" my baseline for the security. Sure, you would buy more shares in the $60s, but that time may never come.

Johnson & Johnson recently reported first-quarter results for 2016 and provided adjusted earnings-per-share guidance of $6.53 to $6.68 per share for the year. We'll use the midpoint as a starting guide.

Intermediate-term growth rate estimates for the company are coming in around 5% to 6% per year. If earnings were to grow at 5.5% per year, that would equate to a future earnings-per-share number of about $8.20 after five years.

Over the past couple of decades, shares of Johnson & Johnson have traded with an average earnings multiple near 20. Of course, a good portion of that was a result of the run-up during the tech bubble and higher general valuation when the company was growing by double digits. Over the past 10 years, the average multiple has been closer to 15. Although once again, you have a bit of caveat in the way of shares trading in the 12 to 14 range after the recession. For a long time, shares stuck around in the $60s before quickly jumping up to the triple digits.

So as a starting point, I'd suggest something in the 15 to 20 times earnings range is reasonable, perhaps erring toward the lower end. Let's use 16.5 to continue with the demonstration. Should Johnson & Johnson earn $8.20 in five years and trade at that sort of multiple, this would imply a future price of about $135.

Next, we can add in the dividend payments. Johnson & Johnson's dividend record is impeccable - having not only paid but also increased its payout for 53 straight years. Given that the company has made four straight $0.75 quarterly payments, you would anticipate the next payment to be a bit higher. For this demonstration, we can use the same 5.5% presumed growth rate, keeping in mind that this is merely a starting point.

In this case, you would anticipate collecting $18 or thereabouts in per share dividend payments. Your total anticipated value after half a decade would be about $153. Expressed differently, using a starting share price of around $112, you might expect total returns on the magnitude of 6.4% per annum. As a point of reference, that's the sort of thing that would turn a $10,000 starting investment into $13,500 or so after five years (prior to thinking about reinvestment).

This is what I mean by a "fair deal." Obviously, what actually occurs could be much better or worse, and thus your range of potential returns is much wider as well. Yet as a baseline, thinking about something in the 5% to 8% range as a potential annualized gain makes some sense (and ought to be adjusted accordingly to your own expectations).

Now, I don't bring this up because it's an unbelievable return. It's certainly nothing to text home about. I mention it because I think that this sort of thing can be easy to overlook. A lot of times we can get caught up in a past price or see a slightly higher valuation and instantly ignore the security. Yet "slightly higher" and "negative" are two very separate items.

Johnson & Johnson is not a security trading with an exceptionally high or low valuation. Instead, it's a great business being offered at a reasonable valuation. And while you might not be particularly interested at today's price, I think this is useful thing to keep in mind. It reinforces the idea of why you're happy to continue holding or reinvesting - it's just as much about the quality as the expected returns. And it keeps the security on your radar. We might not see $60 a share again, but even something closer to $100 still turns "fair" expectations into the possibility for solid gains rather quickly.

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.