Longer-Term Trading Idea for Johnson & Johnson (JNJ)

09/01/2010 12:01 am EST

Focus: STOCKS

It seems like Johnson & Johnson (JNJ) can't catch a break these days. Since September 2009, the company has had announced eight recalls, one of which was on millions of bottles of children's Tylenol, one of the most trusted over-the-counter medicines in the world. Just this week, news came out that JNJ was recalling hip implants, and Acuvue contact lenses in Japan.

Light at the End of the Tunnel

Indeed, things look bad at the moment for JNJ, one of the world's most respected and successful companies. But despite the numerous recalls, JNJ still remains a company with an incredible catalog of products used all over the world and trusted by millions. JNJ is not taking the recall lightly and neither should investors, but those looking at the big picture should sense an opportunity on the horizon. Year to date, shares in Johnson & Johnson have fallen by nearly 11%, vastly underperforming the S&P 500. As a result, the stock now sells for under 12 times current earnings and yields nearly 4%. That compares with other giant consumer products companies like Colgate Palmolive (CL) and Procter & Gamble (PG), both of which have higher earning multiples and lower dividend yields.

Sure, the recalls coming all at once look bad, but it's not the first time, nor likely the last, that JNJ will have to deal with these issues.

Value of Forward Thinking

Since 1994, JNJ has increased its dividend every single year without interruption. From 29 cents in 1994 to $1.93 at the end of 2009, shareholders have gotten a little more back each year. Over the past decade, the dividend has grown by about 10%, on average, every year. If one assumes that JNJ will increase the dividend by a comfortable 7% a year for the next ten years, the dividend will have just more than doubled during that time to about $4 a share. So if you assume Johnson & Johnson shows no sales or profit growth over the next decade and the stock price goes nowhere, the $4 dividend will represent a 7% yield. That's an extremely conservative scenario for this company, which has delivered decades of consistent sales and profit growth. Yet even under those conditions, investors will be making a quality 7% return. That may explain why Berkshire Hathaway (BRK-A; BRK-B) nearly doubled its holdings in JNJ in the second quarter of 2010.

Already trading at a low price on Tuesday, it’s highly unlikely that JNJ's stock price in a few years will be the same as today. Value Line estimates EPS of over $6 within the next three to five years. At a rock bottom 12 multiple, that gets you a $72 stock price.


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A Safe Bet 

Earnings estimates aside, the case for preservation of capital along with capital appreciation is as strong as ever at Johnson & Johnson. Again, sure, the recalls coming all at once look bad, but it's not the first time, nor likely the last, that JNJ will have to deal with such issues.

By Sham Gad, author, The Business of Value Investing and blogger at shamgad.blogspot.com

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