Will JNJ Bounce Back by the End of the Year?

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Shares of Johnson & Johnson (NYSE: JNJ) haven’t performed well in recent weeks despite the positive third quarter financial results of the company. The recent decision of Warren Buffett to sell shares of JNJ didn’t help the stock. Will the company’s stock rally by the end of the year? Let’s examine the recent changes in the company's financial situation and see what could have impeded the company’s growth in revenues and earnings in the recent quarter. 

Shares of Johnson & Johnson have changed direction and declined in recent weeks: during November, JNJ's stock has declined by nearly 2.2%, but it is up by 7.1% year-to-end. The S&P500 has also slightly declined during the month by 1.8%. JNJ’s stock has slightly under performed the S&P500 index during the year as indicated in the chart below (normalized prices of S&P500 and JNJ as Jan. 3, 2012).  During 2012, the linear correlation between JNJ and S&P500 reached 0.62, which means, under certain assumptions, almost 38% of JNJ's stock movement could be attributed to the changes in the S&P500. The strong correlation between the S&P500 index and JNJ's stock suggests that part of the recent fall of JNJ's stock in recent weeks may have been due to the decline in the stock market.

<img src="/media/images/user_12845/jnj-and-snp-nov-2012_large.jpg" />

Let's analyze how JNJ is doing compared to other pharma companies in terms of profitability and dividends: in the chart herein are the operational profitability of JNJ, Merck & Co. (NYSE: MRK) and Pfizer (NYSE: PFE). As seen, JNJ hasn’t recently done much better than its competitors in terms of operational profitability: during the third quarter the company’s operational profitability reached 21% in the third quarter of 2012 compared with Merck’s operational profitability of 19% and Pfizer's 21%. In the previous two quarters, however, the profitability of JNJ was higher than the two other companies. In any case, the profitability of JNJ has declined from Q3 2011 to Q3 2012, from 24% profitability to 21%. This decline may have contributed to the decline in the company’s stock.

<img src="/media/images/user_12845/jnj-oper-profitablity-2012-nov_large.jpg" />

During the third quarter the company’s revenues rose by 6.5% compared to the third quarter of 2011. Conversely, the company’s operating earnings declined by 7.5%.

One factor that may have contributed to the drop in earnings is the growth in JNJ’s expenses in research and development: during the third quarter the provision for R&D rose by only 8.5% compared to the parallel quarter of 2011. If the company will continue to increase its budget on R&D it could lower the company’s profit margin but raise the chances of future growth by developing new products.

A close look at the company’s revenues breakdown (see below) reveals that the company’s growth was curbed by the adverse effect of the currency changes in all JNJ’s major segments. 

<img src="/media/images/user_12845/jnj-sales-sep_1_large.jpg" />

The company has three main segments of operations: Consumer, Pharmaceutical and Medical Devices, Diagnostics. As seen above, based on the recent third quarter reports, the revenues of all three key segments growth was impeded by the currency changes: the strongest effect was in the consumer segment with a 5.3% drop. In this segment, however, was also the lowest operational growth among all segments. The company continues to present strong growth in its largest segment, medical devices, with a reported growth of nearly 16% from third quarter in 2011 to Q3 2012.  

In regards to the recent developments in the forex markets, the fiscal cliff the U.S economy faces along with the possibility that the Fed introducing additional monetary stimulus by the end of the year could suggest that the fluctuations in the forex market will continue to have an adverse effect on the company’s growth in revenues in the last quarter of 2012.

In terms of dividends, JNJ is currently offering slightly low yearly yield: the yearly dividend yield of JNJ is 3.5%, Merck offers 3.9% and Pfizer pays 3.65%. This is another factor that should make JNJ less appealing as an investment than the other above mentioned companies.  

The bottom line  

The rise in the company’s earnings and revenues didn’t help the company’s stock to rally in recent weeks. The decline in the stock market and the decision of Buffett to cut his position in the company may have contributed to the decline in JNJ’s stock. The rise in R&D and the changes in the forex market contributed to the drop in the company’s profitability. This could suggest that the company still has a strong standing and may rally in the months to follow, assuming the stock market won’t hold back the company progress and the changes in the forex market will have a weak effect on the company’s revenue growth.  

For further Reading: Is Exxon Due for a Rally?

Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.


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