For investors, it is important to understand the net effects of the Tax Cut and Jobs Act of 2017 that cut the corporate tax rate from 35% to 21%. It would be easy to assume that the tax cut means that each share of a company in which you invest is now earning an extra fourteen percentage points in profit compared to what it did on the same revenue stream back in 2016.
The (possibly) unanticipated consequence for the investor to monitor is the extent to which the gains from the tax cuts are competed away versus accretive to shareholders–i.e. to what extent do the benefits of the tax cut go to the consumer/end user of products and services, and to what extent do they accrue to the shareholders of the businesses that received the tax cut?
For instance, if you look at the production of machinery in the oil industry, the landscape is so cost-competitive that prices of oil rigs (amid the slowdown in the price of oil as well) has resulted in prices of oil machinery being cut by almost 20% since 2016. The tax cut likely facilitated lower prices for oil-industry related machinery so it is the consumers rather than owners of oil rig manufacturers that have benefited.
Elsewhere, the shareholders of companies stand to benefit from the tax cut. Aside from maybe Apple (and I say “maybe” because of the countervailing issues with possible tariffs), no company stands to benefit in a long-term, sustainable way from the tax cut quite like Johnson & Johnson.
Between 2017 and 2019, Johnson & Johnson has already seen its profits climb 12.11% annualized (from $5.40 to $6.80) even though its revenues have only climbed from 3% (from $76 billion to $81 billion).
Across the globe, Johnson & Johnson is raising the prices of its products without experiencing a corresponding increase in its costs of production. It sells consumer products like Listerine and Band-Aids and Johnson Baby Shampoo that have increased in cost by an average of 8% annually over the past two years (and 5% annually over the past ten) even though the costs of producing these products have only increased by 2%. It sells anti-psychotic, contraceptive, and gastrointestinal medicines that are patent-protected and experiencing 11% growth in profits over the past decade (and 16% annual growth over the past two years). And then it has a medical device division, which has grown at a 17% annualized rate since 1993 (and has experienced twenty-one percent annual growth in profits over the past two years).
For much of the past ten years, Johnson & Johnson was sourcing its profits through Ireland and then funneling the money to be the best opportunities in the EU area where it wouldn’t have to pay repatriation taxes to the United States (which, prior to the tax cut, meant a 35% repatriation tax obligation for returning funds to the U.S.). Now, it has brought $15 billion back to the United States since 2017 that can be sourced to whatever project in the world it deems the most beneficial to shareholders.
From 2009 to 2019, earnings per share growth at Johnson & Johnson was only 3% per year. There really wasn’t any net profit growth from 2013 through 2017. Now, the stock trades around 20x earnings, which has largely been JNJ’s stock valuation for much of the past twenty years, but the five-year earnings per share growth rates look much more attractive.
It wouldn’t surprise me to see profits per share exceed $12 per share in 2025 and the stock trade somewhere around the $250 per share price range at that time (plus, I would expect that shareholders would collect around $25 per share in dividends over that time as well).
The company looks locked and loaded. It should have around $20 billion in cash on its balance sheet by year end. Its consumer division is holding market share, resisting generic pressures, and is experiencing volume growth amid price hikes (often the tell-tale sign of a strong brand). Its medical devices are increasing substantially backed by the secular tailwind of an aging population and ever-evolving “legal standards of care” in which medical negligence can be imputed to hospitals that use outdated medical technologies (meaning these products have to be purchased new again every few years). And the pharmaceutical division is earning the same mouth-watering profit margins as its drug industry peers but Johnson & Johnson shareholders are insulated from the ups-and-downs of the drug cycle because there are consumer and medical device subsidiaries to insulate them from the cyclical risks inherent with drugs that eventually go off-patent.
On a risk-adjusted basis, Johnson & Johnson is very hard to beat. It has the earnings quality of one of the top ten firms in the world (i.e. if a Great Depression were to strike tomorrow and stick around for five years, and I could only divide everything into ten companies, Johnson & Johnson would get one of the slots). And now, it is positioned for ten to twelve percent annual earnings per share growth over the next five years while only trading at a price of around 20x earnings. It fits the profile of buying a wonderful company at a fair price.