Catch a Fallen Angel
12/23/2005 12:00 am EST
"We’re looking to catch a fallen angel, an investment strategy that allows us to play defense and offense simultaneously " says Richard Band, long one of my favorite advisors due to his common sense, unhedged—and historically accurate—advice.
"Fallen angels are solid, industry-leading businesses that have been unreasonably knocked down in price by some temporary factor. For long-term growth, we’re snapping up world-class businesses, one by one, as their shares pull back to attractive prices. This month, I encourage you to go back to the well for more shares of a blue chip healthcare franchise, Johnson & Johnson (JNJ NYSE).
"Famous as one of America’s most trusted brands, JNJ makes a wide array of products from Band-Aids to high-tech medical instruments. The company also holds the remarkable distinction of having grown its earnings at a double-digit rate, compounded, for more than a century. We’ve owned Johnson & Johnson twice in the past five years, and we’ve made good money on it—a total return of 96% if you bought the stock both times.
"Right now, though, JNJ is embroiled in a legal brawl with Guidant, the maker of pacemakers and other medical devices. JNJ had agreed last December to buy Guidant for $25.4 billion. Starting in late May, Guidant has issued a series of warnings about malfunctions in its defibrillators and pacemakers—and even had to pull several defibrillators off the market during the summer. Eliot Spitzer, New York’s finger-in-every-pie attorney general, has sued Guidant for fraud. Investigators in 34 states are also hot on the trail.
"As the news got worse, JNJ threatened to take advantage of an escape clause in the merger contract and walk away from the deal. At first, Guidant stonewalled and filed suit against JNJ. But then, on November 15, Guidant suddenly agreed to cut the purchase price 15%. In my judgment, this $3.9 billion haircut should amply compensate JNJ for the legal costs that will come with the Guidant acquisition.
"Trading at 17 times next year’s estimated profits, JNJ is very cheap for one of the world’s strongest and safest companies. A decade ago, before the Wall Street bubble got out of hand, it was common for the stock to trade at 20–25 times earnings. Over the next three or four years, I look for JNJ to roll up a total return, including dividends, of 70%–100%. Investors should buy JNJ at $62 or less. The stock pays a 2% dividend, with increases like clockwork for the past 43 years in a row."