Is This Great Stock Trading for a Great Price?
Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
One of my favorite Warren Buffett quotes is that it’s far better to buy a wonderful company trading at a fair price than a fair company trading at a wonderful price. While there’s certainly a ring of truth in that statement, most investors would probably also agree that the price you pay for a stock matters. Invest in a vastly overvalued company trading at exorbitant multiples, and you’re likely to earn subpar returns no matter the quality of the underlying company. These are the pressing questions at hand if you’re considering Johnson & Johnson ), one of the highest quality businesses on the planet that happens to be trading at an all-time high. Is Johnson & Johnson still a good value? Or, is this high quality blue chip's price too steep, with better alternatives among mega-cap pharma stocks?
A world-class stock
Johnson & Johnson is a $215 billion pharmaceutical giant. The company has a diversified business line of medical devices, pharmaceutical medicines, and consumer products. It has a wide variety of well-known consumer products including Band-Aids and Listerine.
The company reported solid full-year 2012 results. Revenue increased more than 3% year over year, and diluted earnings per share clocked in at $3.86, representing an increase of more than 10% versus the prior year. Johnson & Johnson delivered yet another year of reliable, if not spectacular, operating results. The company isn’t likely to hit a home run with its sales and earnings growth, as many of its products are defensive in nature. However, J&J offers investors comfortable growth and the consistency investors need to sleep well at night.
In April 2012, J&J provided investors with a 7% dividend increase to its current level of $2.44 per share. This marked the 50th consecutive year of a dividend increase, an enviable dividend track record most companies would love to have.
A different take
While the company's recent performance was good, its stock performance has been even better. The company now trades for an all-time high after rallying more than 17% since the beginning of 2012. When it comes to climbing valuations, Johnson & Johnson isn’t alone within the healthcare sector. Many healthcare stocks have seen big rallies in their share prices and now command lofty valuation multiples of earnings and cash flow.
Like Johnson & Johnson, Pfizer ) announced solid full-year 2012 results. The company’s reported diluted earnings per share came in at $1.94. While the company is currently trading for a reasonable 14 times these earnings, full-year 2012 revenues declined 10%. Management blamed the loss of Lipitor for the bulk of the decline.
You might be concerned about Pfizer losing Lipitor, and for good reason. Lipitor accounted for $9.6 billion in sales for Pfizer in 2011, almost as much as the company's next three best-selling products combined. The company will have to allocate significant resources if it wants to replace these lost sales, which will take a toll on the company’s bottom line going forward. Indeed, Pfizer is forecasting reported diluted earnings per share to be in a range of $1.50 to $1.65 for fiscal year 2013. As a result, the company is trading for more than 17 times the midpoint of its guided 2013 range.
Meanwhile, fellow big pharma peer Eli Lilly ) reported full-year 2012 revenues declined 7% year over year and earnings of $3.66 per share. Consequently, the stock now trades for a modest 15 times trailing earnings. While Eli Lilly’s share price has performed very well recently, increasing more than 20% in 2012, the company hasn’t provided investors with a dividend increase in almost three years. Because its stock price has risen so much over the last couple years, the yield is now down to 3.5% at recent prices. Going forward, management hasn’t provided guidance as to when the company will resume increasing its payout.
The Foolish takeaway
Both Pfizer and Eli Lilly trade for lower earnings multiples than Johnson & Johnson, but you could argue for good reason. Pfizer is in the midst of trying to replace its best-selling drug, and Eli Lilly can’t offer definitive guidance on its next dividend increase, something J&J investors take for granted.
Johnson & Johnson holds a fantastic financial position and superbly profitable business. As a matter of fact, J&J is one of only four U.S.-based companies to hold a triple-A credit rating from Standard & Poor’s. You could certainly do worse than one of America’s best companies accompanied by a 3% dividend yield. At the same time, it’s worth remembering that the price you pay for a stock matters.
At recent prices, Johnson & Johnson trades at an all-time high. J&J exchanges hands for 20 times its trailing twelve-month diluted earnings per share. That figure places its P/E ratio at its highest point over the last five years. More plainly stated, investors are paying more for $1 of J&J’s earnings than at any point over the last five years. Johnson & Johnson isn’t expensive, but I feel at this level it's fully valued. There’s no harm in waiting for a better buying opportunity. I’ll be placing the stock on my watch list in case a more attractive entry price presents itself.
rciura has no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!