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Johnson & Johnson (JNJ) - Thesis

Rating: BUY

Current Price: $95.06

Price Target: $122.60


Johnson & Johnson is a blue chip among blue chip companies, and now is an excellent time to buy.  JNJ has an amazing track record of increasing its adjusted earnings for 31 consecutive years and increasing its dividend for 53 consecutive years.  The dividend yield is currently an attractive 3.2%, and the stock price has recently pulled back making now a great time to buy.

Operating across its three main segments (Consumer, Pharmaceutical, and Medical Devices), the company is home to many names you’ve heard of (e.g. Band-Aid, Tylenol, Listerine, Visine) and many other great health care products people rely on around the world (you can view the company’s products here).  In fact, Johnson & Johnson sells products in virtually every country in the world.  The company’s global sales gives investors an added level of diversification beyond just the diversified products and business segments.  In 2014, JNJ had $74.3 billion in total sales.  Forty-three percent of the sales came from the Pharmaceutical segment, 37% from Medical Devices and the remaining 20% from the Consumer segment.

We value JNJ using a 50/50 combination of discounted free cash flows and Ben Graham’s (EPSx(8.5+2xGr)) formula.  In both valuations, we assume the company can grow at 5% per year.  The average 5-year earnings growth estimate of the 19 professional analysts included on Yahoo Finance is 4.96%.  We believes JNJ provides will benefit from a global demographic trend which the company aptly explains as follows: “the historic aging rate of the world’s population, along with a growing middle class around the world, brings dramatically greater demand for higher quality health care” (Annual Report, p.3).  Our discounted cash flows analysis uses a 9% required rate of return (CAPM derived), and values JNJ at $131.54 per share.  Graham’s formula assigns the company a $113.65 price per share.  We use the average of the two to value JNJ at $122.60, which is well above its current price.

JNJ has a history of returning cash to shareholders through dividends and share buybacks.  As mentioned previously, the dividend has increased for 53 consecutive years.  In aggregate, the company paid $7.8 billion for dividends in 2014.  They also repurchased $7.1 billion of its own stock (this is another way to return cash to shareholders).

Buying Opportunity:
JNJ’s stock price is down this year for two main reasons, and the fact that it is down makes now a good time to buy.  First, JNJ is down with the rest of the broader market.  As bad economic data out of China and jitters about the US Federal Reserve’s upcoming interest rate hike have hit JNJ just like almost every other stock in the market.  And second, JNJ earnings are being hurt by foreign currency fluctuations.  Specifically, the strong US dollar makes international sales less profitable for the company.  However, these two things make JNJ more attractive now than it was before because the broad market pullback is only temporary (the world will go on) and foreign currency volatility is stabilizing. (currency markets have been highly volatile since the “Great Recession” on 2008-2009). 

The main reason most individual investors buy Johnson & Johnson stock is for the dividend.  It’s a steady stable company, and the dividend payments keep rolling in quarter after quarter.  However, the stock also offers the opportunity for capital appreciation.  And while there is no guarantee the stock price will go up tomorrow, this month, or this year, we believe strongly it will go up over the long-term.  As the company says “the historic aging rate of the world’s population, along with a growing middle class around the world, brings dramatically greater demand for higher quality health care,” and JNJ is a leader in meeting these needs.

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