Johnson & Johnson Stock: The Acquisitions Continue

Legendary UCLA basketball coach John Wooden was famous for saying “preparation is the prize.”

He explained what he meant by this concept on page 53 of his biography “Wooden: A Lifetime of Observations and Reflections On and Off The Court.”

Wooden’s comment: “Cervantes wrote, ‘The journey is better than the inn.’ He is right and that is why I derived my greatest satisfaction out of the preparation–the ‘journey’–day after day, week after week, year after year. Your journey is the important thing. A score, a trophy, a ribbon is simply the inn. Thus, there were many, many, games that gave me as much pleasure as any of the ten national championship games we won, simply because we prepared fully and played near our highest level of ability. The so-called importance of a particular game didn’t necessarily add to the satisfaction I felt in preparing for the contest. It was the journey I prized above all else. Too often we neglect our journey in our eagerness or anxiety about reaching the goal. A successful journey becomes your destination and is where your real accomplishment lies.”

As I have gotten older, I have spent more time thinking about the manner in which economic success is created rather than an exclusive focus on which strategy offers the highest end point.

This shift in philosophy has caused me to redouble my appreciation for truly exemplary generational investments like Johnson & Johnson (JNJ). Most of you already know about the company’s extraordinary 22% profit margins in the healthcare industry and record dating back to the 1960s of giving shareholders dividend raises each year.

But as I have noted in the past, what has really caught my attention about Johnson & Johnson these days is the amount of cash that the company has on hand. It is the exact opposite of a firm like General Motors which is extremely debt-heavy and carries far more bankruptcy risk during downturns in the business cycle that could be entirely avoided if managed conservatively. The cash balance at Johnson & Johnson has swelled to $42 billion this year, while the debt burden has held steady in the low $20 billion range.

If you’re trying to turn $10,000 into $500,000 over the next thirty years, you need to think about what that experience is going to be like in 2017, 2018, 2019 and so on–you can’t just imagine what things will look like on some imaginary day in 2046.

There is where a stock like Johnson & Johnson comes in handy with your life’s estate planning: it’s a darn near perpetual escalator upward. I’m not referring to the price of the stock. Prices can and do fluctuate, and Johnson & Johnson traded in the $60 range in 2012 after hitting $70 per share in 2003.

But I do mean that there is an overwhelming probability that the dividend will go up every year, and there has been only one year in the past twenty-five in which the profits generated by the business failed to grow.

The elevator pitch for Johnson & Johnson is that you got a starting dividend yield of 2.7% that will grow by 7-10% annually, you get 6-7% core earnings growth, an extra percentage point from share repurchases, and you also get an extra percent or two tacked on from the deployment of the $42 billion cash hoard for bolt-on acquisitions.

The bolt-on acquisition aspect of the story played out yesterday when Johnson & Johnson laid out $4.3 billion in cash to purchase the medical optics unit of Abbott Labs. It makes about $100 million in profits, putting the takeover premium in the 40x earnings range. It will only add 1% to Johnson & Johnson’s overall earnings at first, but it ought to comprise about 3-4% of Johnson & Johnson’s overall earnings in 2020.

And the price of the stock, which has been hovering in the upper $110s, is a fair price to add to the position. Paying a bit under 20x earnings for one of the top ten businesses in the world that pays out a solid growing dividend and carries the possibility of earnings growth in the 10% range will always meet my idea of intelligent behavior.

For investors that purchase Johnson & Johnson and commit to it for the long haul, there is a strong likelihood that the investment value will double every six to seven years assuming dividend reinvestment. Not only is that end-game satisfying, but so is the process. You will see organic earnings grow on their own. You will see the dividend grow every year. You will see the huge cash position get used to add new businesses to the mix. You get the defense of the dividend with the offense of acquisitions and organic growth. It is the type of investment that is not only financially satisfying, but provides an experience that is psychologically pleasing as well.

Originally posted 2016-09-17 14:04:58.

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