Over time, if a company trades at wildly different valuations, the purchase price of the stock is going to mean that investors in the same company are going to have very different experiences with their holdings. For instance, investors in tobacco manufacturer Altria have seen the price of the stock fluctuate between 10x earnings and 20x earnings at various points in the past five years. Those investors are going to have very different experiences.
On the other hand, there is the well-known blue-chip stock Johnson & Johnson. The investor community generally understands that the company is a powerhouse with unassailable consumer brands (Band-Aids, Listerine, Johnson baby shampoo, etc.), medical device and equipment manufacturing, and a drug pipeline whose irregular yet high growth is “smoothed out” by the first two business categories.
Due to the widespread knowledge that Johnson & Johnston will most likely , Johnson & Johnson has traded at a valuation of between 18x earnings and 22x earnings on 1,943 of the last 2,000 trading days. That type of tight valuation band means that if you buy shares of Johnson & Johnson under a programmatic accumulation scheme (i.e. dollar-cost averaging or DRIP investing), you are likely to experience the investment returns of the business as a whole.
From 2004 until today, Johnson & Johnson has compounded at a rate of 9.5%. If someone had chosen to dollar-cost average into Johnson & Johnson stock continuously throughout this time, the compounding rate would be 9.3%. If you initiated your investment in Johnson & Johnston stock in 2005, 2006, 2007, 2008, 2013, or 2014, you would have also achieved total compounding returns at various points between 8% and 10%.
That matches what you should have expected, as Johnson & Johnson grew earnings per share at a rate of 7.1% annualized during this fifteen-year period and paid out a dividend of 2.3% on average as well. If the stock’s valuation were held constant, you would expect returns of 9.3% which is very close to the real-world experience.
The healthcare giant remains a financial fortress. Between 1990 and 2019, its profit margins have remained consistent around 21% to 24%. Management has grown the enterprise from a $7 billion profit engine in 2004 to a firm earning $18 billion in net profits per year today. Coincidentally, it is also sitting on $18 billion in cash. The pension obligations are almost entirely funded (in a worst-case scenario, Johnson & Johnson would have to kick in $4 billion over the next decade, or the equivalent of about a single quarter’s profits if the management of the pension assets dramatically underperformed).
If you look at the company’s core consumer brands, such as Aveeno, Listerine, Neosporin, Band-Aid, and the collection of baby care products bearing the Johnson’s name, you will see that the company is calculating that the value of the intellectual property behind the brands is increasing at a rate of about 5.5% per year. This is converted into pricing power, as Johnson & Johnson has increased the prices of its consumer products by 5.9% annually since 2004 while generic pricing has only increased at a rate of 3.7%, or slightly above the inflation rate of 3.1% annualized, during the same time frame. Notably, Johnson & Johnson’s volume sales increased at a rate of 3.8% for its consumer brands during this time frame compared to 2.4% for competitors. In other words, Johnson & Johnson is raising the prices of its consumer products faster than its peers and still growing the absolute number of products sold at a faster rate than the competitors.
If I have any investment secrets, it is that I strongly favor brands with intellectual property that translates into demonstrated pricing power in the form of higher-than-industry price hikes coupled with higher-than-average volume gains. It means something special when people clamor for you even when you’re not the low bid.
I am intrigued by obvious investments sitting there in plain sight that often outperform the overly complicated or sophisticated alternatives. If you decided in 1989 to invest $100 per month into Johnson & Johnson stock and continued to do it through this day, you would have invested $36,000 of your own money and would have created $297,632.33 in additional wealth for a total value of $333,732.22 for a total compounding rate of 12.4% annualized (with dividends reinvested, otherwise the returns would have been 10.6%). Meanwhile, someone that invested in the typical U.S. hedge fund would have achieved an average return of 6.5% for a total of $71,264.07. You’d end up with 4.7x the value of your $100 monthly investment just by recognizing a great business and making a modest yet ongoing contribution to it for the long haul.
Pull up the company’s annual report. It is a beauty of a firm. It has grown year-over-year profits in 47 of the past 50 years. It has never gone two years in a row without growing profits per share in the past half-a-century. If you get your hands on a share, you can be as sure as is possible in the world of publicly traded securities that the intrinsic value is going to increase over time. The company is diversified across three sectors and over 40 subsidiaries doing over $250 million in annual business in 160 countries. It generates $82 billion in annual revenue. From an economic activity perspective, Johnson & Johnson is the size of Guatemala. You can think of your share in Johnson & Johnson as a stake in the 69th-largest country in the world.
Five years from now, Johnson & Johnson will be earning $30 billion in profits and generating $12 per share in profits. It just keeps chugging along at a high single-digit pace and paying out half of its profits as dividends which usually means a 2-3% dividend yield. It is on the short list of ‘Ole Reliables of the investing world. And with Schwab and other brokerage houses eliminating commissions, there is nothing stopping you from accumulating shares every month as you go through life. Considering the overwhelmingly high likelihood of success, the compounding rate at triple the rate of inflation is nothing short of incredible. And it just sits there, waiting for you to combine knowledge with action.