(Published Nov. 1 by Bob Ciura)
Johnson & Johnson (JNJ, Financial) has an incredible history. It was founded all the way back in 1886 by three brothers – Robert Wood Johnson, James Wood Johnson and Edward Mead Johnson.
Johnson & Johnson was incorporated in 1887. The following year, the three brothers published “Modern Methods of Antiseptic Wound Treatment,” a manuscript that would quickly become the standard for antiseptic surgery techniques. The same year, the three brothers began selling first aid kits, which also became the standard among that product category.
From there, Johnson & Johnson gradually unveiled new products, including baby powder, sanitary napkins, dental floss and other products that were the first of their kind.
Today, J&J operates in more than 60 countries around the world and employs 126,500 people.
J&J has increased its dividend for an amazing 54 years in a row. The qualification to be a Dividend Aristocrat is to pay increasing dividends for 25-plus consecutive years (and be in the Standard & Poor's 500). You can see all 50 Dividend Aristocrats here.
J&J matches this qualification more than twice over. It is in an even more select group called the Dividend Kings – stocks with 50-plus consecutive years of dividend increases.
Keep reading this article to learn more about the investment prospects of the king of stability in the health care sector, J&J.
Business overview
J&J is a massive company, with more than 260 subsidiary companies. In all, it manufactures and sells health care products through three main segments:
- Pharmaceuticals (47% of sales).
- Medical Devices (35% of sales).
- Consumer Health Products (18% of sales).
These are all huge businesses. J&J has the world’s sixth-largest consumer health company, the sixth-largest biologics and the fifth-largest pharmaceutical company.
J&J’s large and diversified portfolio have helped the company generate consistent growth for decades. Last year, the company marked 32 consecutive years of growth in earnings per share after adjusting for nonrecurring items like divestitures and acquisitions. This streak of earnings per share growth is the best in the corporate world, to my knowledge. Over the past 10 years, J&J grew earnings per share by 3.8% compounded annually.
One issue the company is dealing with is unfavorable currency fluctuations. As a multinational giant, J&J’s overseas operations are negatively impacted by the strong U.S. dollar. A stronger U.S. dollar relative to other currencies makes exports from the U.S. less competitive, and it pushes down the value of sales generated abroad. Because of this, Johnson & Johnson suffered a 5.7% drop in sales in 2015.
That being said, J&J’s adjusted earnings, which exclude currency effects and divestitures, rose 5.8% in 2015. Organic global sales increased 5.3% last year.
High organic growth is a good indication that the underlying businesses are performing well. Currency movements tend to get smoothed out over time. It is a much better sign that J&J’s products still see high demand.
The company is off to a good start this year. Adjusted earnings per share increased 13% last quarter. J&J enjoyed broad-based growth.
Source: Third-quarter earnings presentation, slide 1
Growth prospects
J&J has encountered some fundamental challenges recently, but its long-term growth prospects are still promising. Its two most attractive long-term growth catalysts are the aging global population and growth from the international markets.
Consumers in developed markets around the world, particularly in the U.S., are aging rapidly. For example, the baby boomer generation is one of the largest generational groups in the U.S. There are many people entering retirement every year. This means it is likely for health care spending to continue rising at a faster rate than GDP, which will be a strong tailwind for J&J.
This is already starting to play out. The strongest area for the company last year was its pharmaceuticals business, which grew revenue by 9.7% from the previous year.
The other huge catalyst for J&J is growth in international markets, particularly the emerging markets. These are markets like China, with large populations and high rates of economic growth. J&J generates a significant portion of its overall business from outside the U.S.
Source: 2015 Fact Sheet, page 2
Competitive advantages and recession performance
In order for a stock to grow earnings per share for more than 30 consecutive years and raise its dividend each year for half a century, it must have an almost impossibly strong and durable competitive advantage.
Johnson & Johnson holds three main competitive advantages that separate it from the competition:
- Massive size and economies of scale.
- Research and development spending.
- Brand strength.
J&J is a huge company with a $317 billion market cap. It has 11 individual products that each collect at least $1 billion in annual sales. This provides it with economies of scale and high profit margins.
J&J’s high profitability allows the company to dedicate significant financial resources to research and development. R&D is critical for a health care company because it provides product innovation. Johnson & Johnson generates about 25% of revenue from products it has developed in the last five years.
J&J spent more than $9 billion on R&D expense last year alone.
Johnson & Johnson has several brand names that command premium pricing because of their high quality. Its consumer health franchise manufactures Listerine, Band-Aids and many others. Approximately 70% of J&J’s total sales come from products that hold the No. 1 or No. 2 global market share in their respective categories.
J&J’s brand leadership and consistent profitability allowed the company to navigate the Great Recession very well. It actually increased earnings per share each year throughout the recession, a rare performance.
- 2007 earnings per share of $4.15.
- 2008 earnings per share of $4.57 (10% increase).
- 2009 earnings per share of $4.63 (1% increase).
- 2010 earnings per share of $4.76 (3% increase).
Valuation and expected returns
J&J stock trades for a price-earnings (P/E) ratio of 20, which is less than the S&P 500 P/E ratio of 24.4.
J&J stock deserves a premium valuation multiple because it is such a high-quality company. It has a strong balance sheet. Johnson & Johnson ended last quarter with $42.5 billion in cash and marketable securities. It is one of only two U.S. companies to have a "AAA" credit rating from Standard & Poor’s, along with Microsoft (MSFT, Financial).
As a result, J&J stock appears to be either trading around fair value in an otherwise overvalued market, or undervalued relative to today’s market – depending on your perspective.
Multiple expansion could provide significant returns. In addition, earnings growth and dividends will add to total shareholder returns. Over the long term, investors can expect 8.7%-10.7% total returns, based on the following factors:
- 6% to 8% earnings per share growth.
- 2.7% dividend.
Earnings per share growth will be comprised of 5% to 7% organic revenue growth, along with 1% to 2% growth from share repurchases. Future returns could be even greater if the stock experiences multiple expansion.
Final thoughts
J&J has an above-average dividend yield and more than 50 years of uninterrupted dividend growth. It has a tremendous balance sheet and a highly profitable business model. Going forward, it should benefit from the aging population and growth in new geographic markets.
As a result, J&J is among the best stocks to own for long periods of time for dividend growth investors. It forms the core holding in the health care sector for many successful dividend growth portfolios. J&J currently has an above average rank using The 8 Rules of Dividend Investing thanks to its stability, long dividend history and above average dividend yield.
Disclosure: I am not long any of the stocks mentioned in this article.
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