Should You Buy Johnson & Johnson?

Bob is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Stocks that stand the test of time are often ones that have a diversified product portfolio of world class brands. Companies such as these, whose products are purchased regardless of the prevailing economic climate, have the financial ability to weather any economic storm.

Few companies have reached iconic stature as Johnson & Johnson (NYSE: JNJ) has over its many decades of dependability and stability.

After a considerable rally over the past couple years, is there still room for J&J to run?

A red-hot sector

Despite its reputation as a lumbering giant, J&J has displayed share price gains over the past year that are anything but slow-and-steady. J&J is up more than 20% just to start 2013, and that doesn’t even include the generous dividend payments the company is known for.

Fortunately for their investors, many of the major publicly-traded health care giants in the United States have followed suit. For example, Pharmaceutical giants Bristol-Myers Squibb (NYSE: BMY) and Eli Lilly (NYSE: LLY) are both up more than 30% over the trailing 52 weeks.

The spiking share prices among these stocks are confusing given the struggling underlying performance of many of these firms. For example, Bristol-Myers Squibb reported full-year 2012 net sales that were 17% lower than the previous year. Likewise, Eli Lilly reported that full-year 2012 revenues declined 7% year over year.

It’s understandable why these stocks are so attractive to investors. Since interest rates are still near historic lows, traditional bank products like certificates of deposit pay almost nothing in interest. Even more aggressive investments like bonds still don’t pay much in terms of yield.

As a result, Bristol-Myers Squibb and Eli Lilly, which both yield in excess of 3%, are seen as reliable places to earn yield in today’s low-rate environment.

Unfortunately, dividend growth hasn’t kept up with the impressive share gains. Bristol-Myers Squibb’s last four dividend increases were only in the amount of one penny per share. Eli Lilly, meanwhile, hasn’t increased its dividend since 2009.

A cloudy picture going forward

Making things even more confusing, it's not as if Eli Lilly and Bristol Myers-Squibb are poised to grow significantly in the near future.

Both companies are undergoing the well-publicized loss of patent exclusivity that the pharmaceutical industry as a whole is struggling to deal with.  This is evidenced by the lackluster growth trajectories expected of each company.

Consider that Eli Lilly and Bristol Myers-Squibb trade for forward P/E ratios of 18 times and 21 times, respectively.

Startlingly, Eli Lilly's 2014 earnings per share are projected to decline 30% from current year expectations, according to data compiled from 19 analysts by Yahoo Finance.  This is primarily why Eli Lilly hasn't given guidance as to when investors can finally expect a dividend increase.

Meanwhile, Johnson and Johnson holds a much more impressive dividend history than its two rivals, and due to its diversified product portfolio, will continue that streak for a long time.

Consider first the company’s fantastic track record of rewarding shareholders. In April, 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.

Furthermore, J&J is one of only four non-financial, U.S.-based companies to hold the coveted triple-A credit rating from Standard and Poor’s.

Fantastic company, not-so-fantastic price

Johnson & Johnson is simply one of the highest quality stocks in existence. It is a world-class brand with a diversified stable of products that are found in millions of households.

Furthermore, its stable business and formidable financial position mean that it will continue paying dividends, along with annual dividend increases, for years to come.

At the same time, it’s hard to make the case that the stock is a screaming bargain.

J&J has fallen a few dollars off its recent highs, but the stock still trades for 15 times forward earnings and for nearly 4 times its book value.

There’s no denying the fact that J&J perfectly epitomizes the phrase ‘blue chip’, but it’s also true that even spectacular companies can be mediocre investments if too high a price is paid.

I would love to own J&J stock, but can’t bring myself to buy just yet. I would consider the stock to be close to entering buy territory if it yields 3.5% or more, which at its current dividend, would be below $70 per share.

This represents a considerable downturn from the stock’s current price of $84 per share, but in today’s atmosphere of enhanced volatility, I’m content to wait on the sidelines for the market to offer a better price for J&J.

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Robert Ciura 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!

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