While the valuations of a lot of S&P 500 businesses have run up in the aftermath of the election, the stalwart healthcare firm Johnson & Johnson (JNJ) has continued to trade within a zone of reasonableness at a price of $115 per share. It is by no means “on sale” at this price, but it does offer an opportunity to own one of the highest quality businesses in the world at a fair price.
The reason I get so excited about my coverage of Johnson & Johnson stock, compared to another business that also has blue-chip investment status such as Campbell Soup, is that it is more than just “earnings quality.” Yes, the $12.9 billion profits held up during the 2008-2009 recession, and yes, the dividend is well supported by current earnings and has a history of increasing every year.
But Johnson & Johnson has the likelihood of high future earnings growth that a business like Campbell Soup lacks. Not only does Johnson & Johnson have an enormous presence in a demographic that will provide a generational tailwind, but it earns 22% net profits on products whose annual growth has never been less than 2.5% at any point in the past 25 years. Its pharmaceutical division is growing earnings by 8%, and the stodgy consumer healthcare division grows at 2% (but comes with the benefit of stable earnings during a recession.)
The result is that you get a business with core organic growth of about 5-6%. Shareholders are also benefitted by a stock repurchase program that retires about 1% of the outstanding stock in a given year, which acts as an autopilot way to increase your ownership of the business by buying out some of the other owners.
And the complementary element, which I have harped on a few times, is that Johnson & Johnson has the balance sheet strength to make big acquisitions that can bolt onto earnings. As of last quarter, Johnson & Johnson’s cash position crossed the eye-popping $40 billion mark. There is an issue with about $25 billion of it being overseas and subject to a 35% repatriation tax if it were brought back to the United States under America’s current tax terms, but a little bit of disutility regarding access does not negate the broad conclusion that Johnson & Johnson is in the position to make big acquisitions.
Recently, news broke that Johnson & Johnson is engaged in acquisition talks for Actelion, the maker of pulmonary arterial hyper tension drugs. I imagine a deal could be around $22 billion or so, and my guess is that the P/E ratio on Actelion would be something like 50x earnings which will strike JNJ shareholders as an overpay. There may be something to that criticism, but Actelion is growing earnings at 13-15% annually and you can’t take over a business growing like that without paying a significant premium during present economic conditions.
The bottom-line for me is that Johnson & Johnson has a strong possibility of growing earnings at 8% annually while paying out a 2.8% dividend. With a fair valuation, this means that Johnson & Johnson ought to give 10.8% total returns for shareholders from this point onward. That is objectively a good total return profile, but is even better when you account for the low risk you’re taking on in the pursuit of those total returns–you are basically buying a business so large and diversified that it is almost a healthcare index fund in its own right.
The income growth at Johnson & Johnson, which has averaged 9.5% annually since 2005, ought to continue to do well (though I would guess an emphasis on buybacks and a desire to bring the payout ratio down a little bit means that shareholders will receive 7-8% dividend growth from here over the low long haul.)
This high growth in the dividend gives you the opportunity to diversify into other businesses if you build up a sizable stake in Johnson & Johnson stock before you reach an age at which you need to live off the income. On a grand scale, this is what has enabled the Johnson family to launch Fidelity Investments and purchase the New York Jets football franchise.
Imagine if you invested $1,000 per month into Johnson and Johnson from the age of 30 until 50, an investment period that coincided with the 1980 to 2000 time period. You would have found yourself with a split-adjusted 71,650 shares of Johnson & Johnson stock. Your dividend payments would have been $44,423 in 2000.
But the real cash came during the next sixteen years–each share paid out $30.44 per share. With an ownership stake of 71,650 shares, this means that our hypothetical Johnson & Johnson investor would have collected $2,181,026 in cash from his share of Tylenol profits. That is life-changing cash proceeds resulting from only a moderate amount of initial lifting sustained for a long period of time. If you get your cash generator right, and make a large or ongoing modest commitment to it, the future results dramatically outweigh the initial effort. How can that not make you excited about the prospect of mixing the surplus from your labor with a well-chosen investment? Fidel Castro can keep his dialectical materialism; I’ll take the two-million dollar check.