Johnson & Johnson: Diminished Returns Ahead

| About: Johnson & (JNJ)
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Johnson & Johnson exceeded analyst estimates for Q2.

Ironically, the company continues to signal that the stock valuation is stretched.

While more stock gains are likely in the short term, shareholders will eventually run into a scenario where going forward returns are diminished.

Johnson & Johnson (NYSE:JNJ) remains a strong franchise, but the question remains regarding a stretched value. The company itself continues offering warning signs of the valuation when big initiatives have limited impacts.

Source: JNJ website

The health care products company had a solid Q2 with a big earnings and revenue beat. Revenues though only grew 3.9% over last year. JNJ even increased the yearly EPS guidance, but the new mid point is only $6.68, up from $6.61 prior with the increase nearly equal to the Q2 beat.

A couple of data points stood out as key warning signs that the stock has trading too high. Interesting though, these numbers come from work done by JNJ.

The prime focus point is the capital return plans. When a large company makes a big plan for share buybacks and the impact is minimal, investors need to take note.

Back in October, JNJ announced the intent to repurchase $10 billion worth of shares. The plan was hailed, but the reality is that the higher the stock rises the more it becomes evident that the valuation is highly stretched.

The company spent roughly $1.45 billion on share repurchases during Q415 and Q116 and apparently upped the amount to $2.1 billion during the last quarter. JNJ has spent 50% of the share buyback already for around $5.0 billion, yet the diluted share count has hardly budged in the last year. The share count for the last quarter was at 2,794 million, down only 0.6% from last Q2.

With the market cap now at $344 billion, the amount spent is not very meaningful. Even worse, the company suggests reaching 75% of the buybacks by the end of the year. This amount averages to a pullback in the buyback rate to only $1.25 billion per quarter.

The issue is best highlighted by the below chart. The net payout yield that combines the net stock buyback yield and dividend yield continues to decline as the stock soars. After all, the dividend yield is down to a rather meager 2.5% now.

JNJ Chart

Another key sign from the company is the shareholder returns, especially this year. JNJ performed in the middle of the road over the last decade, but this year the stock has far exceeded the gains of the S&P 500 and the S&P Pharma sectors according to these numbers from the Q2 presentation.

The above slide was probably intended to point out a new day in JNJ. The reality is that the market should take a pause when a mega-cap outshines industry composites by more than 1,500 basis points.

The key investor takeaway is that JNJ is yet another dividend paying stock that has rallied too far. In this case, the health care products company is literally telling people that the stock is too expensive.

As long as the stock chart keeps heading up and to the right, the market is probably willing to pay even more for the stock. Future shareholder returns will only diminish as the stock keeps rallying.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.