Johnson & Johnson stock has grown its dividend by 13% since 1970 and has compounded wealth for JNJ shareholders at a clip of nearly 14% over that same time frame. When you pay attention to any list of excellent long-term income investments—whether the colloquialism of the day is “Dividend King” or “Dividend Aristocrat”—Johnson & Johnson finds itself on every list of blue-chip stocks.
Many of you have already read ad nauseam—perhaps from me!—about the characteristics of this healthcare giant that make it such a superior compounder over the long haul. However, I wanted to take a moment to discuss with you some of the reasons that has made Johnson & Johnson stock such a consistently superior compounder beyond the information that you have regularly encountered.
Why Johnson & Johnson Stock Keeps Growing
Remember our recent discussions about the advantages of using the holding company structure? Well, Johnson & Johnson is the corporate version of that. When you buy JNJ stock, you are actually the shareholder in a holding company. Essentially, Johnson & Johnson stock is a corporate shell that does nothing except own stock in 157 different business lines.
This decentralized structure at Johnson & Johnson is an enormous advantage that reminds me of a line from the 2014 annual report that Charlie Munger used to describe the structure that made Berkshire Hathaway so successful:
“Then, as the Berkshire system bestowed much-desired autonomy on many subsidiaries and their CEOs, and Berkshire became successful and well known, these outcomes attracted both more and better subsidiaries into Berkshire, and better CEOs as well.”
Investors don’t talk about it all that much, but Johnson & Johnson delivers high returns because they utilize a decentralized structure and have 157 different CEOs running each of the subsidiaries that operate under an incentive-laden arrangement. If their units perform exceptionally well, tens of millions of dollars in bonuses await them. If the divisions don’t grow, the executives are quickly replaced.
Each division is siloed off into its own unit that is independently judged. This helps avoid the bloated bureaucracy structure that is often the bane of large firms.
It also makes capital allocation much easier. If a couple hundred million dollars get sent from the Tylenol division up to the New Brunswick headquarters, the management team can turn around and use it to fund a promising drug development in one of the pharmaceutical lines. Some of those 157 businesses, particularly in the consumer division, are in cash cow mode and are great source of capital for the drugs being tested. This low cost of capital is a big reason why Johnson & Johnson earns 24% net profit margins.
It also doesn’t hurt that Johnson & Johnson operates in the healthcare sector with a heavy emphasis on Western nations with aging populations. It experiences a 3-5% sales growth demand for its products every year. This is a nice tailwind which contrasts to another blue-chip stock like Coca-Cola which has to deal with 2% annual declining demands in soda.
My fear is that some activist shareholder will one day see Johnson & Johnson underperform the S&P 500 for some interval of time and persuasively call for the pharmaceutical and consumer divisions to be broken up. You’ll probably hear the jargon phrase “unlock value” get thrown around. I would not vote in favor of such a split, as the consumer division contains many mature brands that generate torrents of cash that can perpetually fund the developing drugs and hospital machinery technology in Johnson & Johnson’s non-consumer lines.
The JNJ Dividend Is Possibly The Safest Payout In The World
There has been a trend in recent years to search for stocks that pay out so-called safe dividends. It is an investing style that ebbs and flows and has its origins dating to the well-known widow and orphan portfolios of the 1930s (the old saying was that stocks like AT&T were so safe and stodgy that widows and orphans who couldn’t afford to venture capital would be the ideal holders). The reason we have seen a renaissance in income investing over the past few years is because interest rates are low and sophisticated financial managers have recognized that Americans bonds have been in bubble-like conditions.
So what characteristics of an income-producing stock can confidently give you the conclusion that the dividends are safe?
Three things: A rock-solid balance sheet, dividend payouts backed by earnings, and earnings that hold up well enough during worst-case scenarios that would fund the continuation of the current dividend payout rate.
JNJ stock meets all three conditions.
First, it has the strong balance sheet outside of Berkshire Hathaway and some firms in the tech sector. It is sitting on $42 billion in cash. This well above the generational average of $23 billion during the 2003-2012 time frame. Profits at the healthcare conglomerate have been stockpiling, and you are probably going to see tens of billions of dollars get spent on bolt-on acquisitions within the next three to five years. Meanwhile, Johnson & Johnson is sitting on an extreme cash hoard that provides a nice backstop to ensure that the dividend keeps getting paid out.
Secondly, you want to see a business that can well support its payout. While I think that some stocks with high dividend payout ratios get an undeserved knock for being “unsafe” because I don’t think the stability of their cash flows are adequately weighed, I do think that Johnson & Johnson stock is an exceptional example of a business that always keeps its dividend payout ratio at a rate that can be well supported.
For the past twenty years, Johnson & Johnson has kept its dividend payout ratio in the band 38% to 53% of earnings. Basically, it keeps about half of its profits as cash on hand, and ships out the rest. This year, Johnson & Johnson is expected to earn $6.75 per share and is currently on the hook for paying out a $3.20 per share dividend. That is a payout ratio of 47% of earnings. $18 billion in profits flow in, $9 billion of that gets shipped out to shareholders as JNJ’s current annual dividend.
And third, the Johnson & Johnson dividend’s current rate is recession tested. There has been only one year in the last thirty in which Johnson & Johnson stock failed to report higher earnings than the previous year. The amount of the decline was less than 3%. These profits are as reliable as you can find. Even if Johnson & Johnson were to repeat its worst year over year results that have ever happened over a twelve month period, it would still only bring the payout ratio up to about half of earnings.
The fact that Johnson & Johnson grew its profits and dividends during The Great Recession of 2008-2010 ought to signal that the business is anti-cyclical enough to get you through the good times. When you combine this with the prudent payout ratio and the enormous cash balance, you can make the argument that the Johnson & Johnson dividend is the safest in the world.
Johnson & Johnson’s Dividend Has Grown By 12% Since 1992
If you were collecting $1,000 in dividends from Johnson & Johnson twenty-five years ago, you would be collecting $19,788 now. And that is without the reinvestment of any dividends. If you did reinvest along the way, your compounding rate nudges up to an astounding 14.3%. That would give you $34,900 in annual dividends. That is obscenely high growth, but that is what happens when you have a fast growing payout with the cash being used to simultaneously buy more shares.
And you know what really helped along your compounding of wealth? The fact that Johnson & Johnson’s stock price languished while its earnings grew. In 2005, you could have purchased Johnson & Johnson for $70 per share. In 2013, Johnson & Johnson could have been purchased for $70 per share. That is an eight-year stretch with absolutely no capital appreciation.
Also, a necessary aside. If you follow the ideas on my site, it is almost guaranteed that a business I cover will experience a similarly long period of no capital appreciation. You can deal with this in three ways. You can just focus on increasing the amount of investable income from your job that can be put into new investments and not worry about the particularized compounding of an individual holding. Secondly, you can diversify your investments and recognize that there will be best performers and worst performers in any collection of assets, and so long as the assets are generally profitable and don’t face the risk of technological obsolescence, you can channel Bob Dylan and know that the first one now will later be last and vice versa because the times they will eventually be a’ changin’. And third, you can practice fundamental analysis and become gleeful when the earnings of your business holdings increase faster than their stock prices.
In the case of Johnson & Johnson, it was to your benefit as a long-term stockholder that the stock price didn’t move anywhere between 2005 and 2013. Why? Because the earnings grew from $3.50 per share to $5.52 per share and the dividends grew from $1.28 per share to $2.59 per share. That was a valuation of 12x earnings and a 3.7% dividend yield.
That was fantastic for your overall compounding. How great was this for your overall wealth building? Well, if you were reinvesting your dividends, each JNJ share tacked on additional 0.3 shares during this time frame. If you owned 100 shares of Johnson & Johnson in 2005, you have 130 shares in 2013. If you had 1,000 shares, you’d have 1,300. And so on.
For a company of Johnson & Johnson’s caliber, that really is a rapidly rising share count due to reinvestment. Those 30 shares you picked up on a 100 share investment in 2005 rise in value to $115 per share just as well as that original lot you purchased. It reminds me of one of my favorite C.S. Lewis quotes from Prince Caspian: Isn’t it funny how day by day nothing changes, but when you look back, everything is different?
Picking up an extra share or two here and there may not seem consequential, but you have to remember: Each reinvested share that you pick up will then grow in value and pay out dividends every quarter for the rest of your life. And this happened at attractive rates for eight years. Perhaps none of the 24 individual reinvestment dates between 2005-2013 had a large impact on your ending wealth, but cumulatively, the effect is much more substantial when you add it all up.
What Should Give Investors The Confidence To Reinvest Into Johnson & Johnson Stock?
If you are going to spend year after year escalating your Johnson & Johnson ownership position in a stock through reinvestment, you want to make sure that there is a solvent business sitting there at the end of your life. You don’t want to be like the Wachovia investor that spent decades reinvesting those 4% big bank dividends only to end up with nothing at the end of their compounding. I call this avoiding the poof points with your capital.
In addition to the strong balance sheet, I am convinced that Johnson & Johnson has some of the best brands in its consumer division that exist in the entire world.
They have Johnson Baby Care shampoo, which has seen its demand increase by 5% annually since 1992. That is high sales growth, which has translated into 9.5% earnings growth. That is the cornerstone name brand when it comes to shampooing infants.
Shareholders of Johnson & Johnson also have a claim on Aveeno, one of the best brands of moisturizers in the marketplace. It has nearly 40% gross margins and experiences demand growth of 3.5% each year which has translated into 7% annual earnings growth.
You can walk through this with so many other brands that are part of the Johnson & Johnson holding company umbrella. Neutrogena. Lubriderm. Rogaine. Band-Aid. Motrin. Tylenol. Neosporin. Benadryl. Zyrtec. Imodium. Sudafed. Listerine. And that’s just from the JNJ consumer division. When you buy a share of Johnson & Johnson, your investment is backed up by a slice of the profits from that expansive collection of businesses around the world.
There are three things I love about Johnson & Johnson’s collection of assets.
First, I love the fact that you envision customers using these products twenty years from now. You can imagine, in 2037, that parents will still be putting Band-Aids on their kids’ boo-boos, washing their mouths out with Listerine, and taking Tylenol to cure a headache. My confidence stems from the fact that these are basic products with timeless demand that is resistant to technological obsolescence, and also, Johnson & Johnson has the institutional heft to launch aggressive advertising campaigns for any products that falter, need to perk up, or grow. Heck, their brand name Band-Aid is the very term we use to describe the adhesive.
Secondly, even if my insight is incorrect regarding the timelessness of Johnson & Johnson’s business lines, the company is such a diverse walking health care index fund that it can easily absorb failures or individual product declines. For instance, Pfizer is aggressively pouring resources into finding a cure for male pattern baldness. If they succeed, that could very well wipe out the entire market demand for Rogaine for some day. But so what? Even if that happens, Johnson & Johnson will still retain 98.5% of its earnings power. It can discard the failures and use the ongoing growth from the prospering units to move on.
Third, I love the fact that these assets are recession-proof. You’re not going to stop using mouthwash because the GDP is done a point. You’re not going to tough it out through a headache and refrain from taking Tylenol because the unemployment rate is up a bit. There are not cyclical seasons associated with Johnson & Johnson’s ability to find a market from its goods.
If anything, the market for its medical device and pharmaceutical divisions is benefitting from a secular tailwind as non-obese Americans continue to enjoy longevity of life and obese Americans may eventually need to take some of the pharmaceutical products and visit a hospital that has medical devices manufactured by Johnson & Johnson. Whether you get sick or fat, Johnson & Johnson is on the other end healing you (which is perhaps a pleasant shift from my typical coverage of businesses like Coca-Cola, McDonalds, and Philip Morris International that send your ventricles flapping shut).
The Wealth Creation Formula With Johnson & Johnson Stock
If you purchase shares of Johnson & Johnson, the theory of how you will make money is loosely as follows: the core businesses experience sales growth of 3% which translates into 5-6% growth, there is an additional point coming from share repurchases since Johnson & Johnson uses part of its $9 billion in retained cash flows to retire shares, there is another point from the deployment of the $42 billion cash hoard to make acquisitions, and there is 2.7% dividend yield. This puts you in the position to receive annual returns in the 10-11% range if you purchase shares of Johnson & Johnson today and let your ownership interest compound upon itself.
If I had to name the businesses that I thought had the greatest change of a future dividend growth compounding rate of at least 8% for the next fifty years, my guess would be a toss-up between Colgate-Palmolive and Johnson & Johnson. That is a drop from the 12% compounding rate that Johnson & Johnson stock has experienced since 1992, and that is my recognition of the limitations imposed by businesses reaching a colossal size and the fact that knocking off a point or two from your projections in the interest of conservatism never hurt anybody.