Take a Look at Johnson and Johnson – A True “Dividend Aristocrat”

glasses-on-chart-ssIf you’re a trader, you might shy away from Johnson and Johnson (NYSE: JNJ) at the moment. The giant healthcare products stock gave up six-plus points in 10 days this month after hitting its all-time high at $106.47 on July 7. What’s more, at today’s close of $102.11 the stock’s dividend-adjusted PEG ratio (PE to estimated 5-year Earnings Growth Rate) is 1.64, a level where stocks are often poised for a drop in price. To top it off, the current short-term technicals are weak, indicating the stock could fall again to $100 or even lower.

But it’s not the traders I’m addressing right now – it’s long-term investors, and if you’re one of those, my recommendation is that you buy JNJ. The reason is the stock’s dividend history, a 51-year record of rising dividends and  little reason to think the trend will be broken in the foreseeable future. That, and the stock’s record of long-term capital appreciation, has produced the kind of respectable, if not spectacular returns that meet the needs of retirees and investors with a moderate taste for risk.

From 2009 through 2013, JNJ generated an average total return for investors of 12.65%, trailing the S&P 500 by 5.20 points. This year to date, however, the stock is beating the S&P by nearly the same difference, 13.07% to 8.09%. Over the last 20 years, that’s close to the norm for JNJ: it’s outperformed the equity benchmark by an average of more than 4 percentage points year, 13.54% to the index’s 9.10%.

But let’s talk dividends. JNJ currently pays an annual dividend of $2.80, for a yield of 2.74%.

Twenty  years ago, the dividend was 28 cents. That represents a truly remarkable increase of 936%, for average annual growth of 12.4%. Over the last 5 years, the dividend has grown by a more modest average of 7.40% a year, and by 9.70% over the last 10. When you’re retired, you need a stock whose dividends grow faster than the rate of inflation. And if you’re not retired, that kind of dividend performance gives you peace of mind when the stock market gyrates.

So, the question is, going forward can JNJ keep up the pace? As I said, it looks like it can, because it’s not straining to keep its dividend track record intact. For one thing, the dividend payout ratio over the last 12 months was a sustainable 40-42%, which also happens to be the company’s 10-year median, meaning the company isn’t cannibalizing its profits, borrowing or selling assets to cover its dividends. The warning flag here goes up when there is a sustained payout ratio north of 75%, and JNJ is comfortably underneath that.

Fundamentally, stock dividends are supported by free cash flow, and there JNJ is in fine shape. For the trailing 12 months ending March 31, JNJ generated $15.4 billion in free cash on a rising trend line going back 20 years. Significantly, its per share ratio of free cash to dividends was 1.91, where 1.20 is the minimum sign of health. And JNJ isn’t likely to have its free cash flow devoured by debt service payments: its debt to equity ratio is just 22.6%, in an industry (major drug manufacturers) where the average is 108.4%.

None of this means anything, of course, if JNJ’s revenues and profits are shrinking – but that’s far from the case. In its second quarter earnings report earlier this month, the company noted that its sales rose 9.1% over the same quarter last year and profits were up 13%. If there’s a fly in JNJ’s ointment, it’s that revenue growth had until recently appeared to be slowing. Over the last 10 years, revenue per share grew at an average of 4.9% per year, fell to an average of 3.9% over the last three years, and was just 3.0% for the 12 months ending this past March. Analysts’ consensus is that after advancing 5.2% for all of 2014, JNJ sales will grow just 2.7% in 2015. On the other hand, Wall Street estimates that the company’s profits will grow an average of 7.1% a year over the next five years, compared to the 5.5% it showed over the last five.

The “secret” to JNJ’s long-term success is that it’s unique in its industry for its broad diversification. Its $73.5 billion in 2013 revenues came from three business segments: consumer over-the-counter health products (21% of sales) – think Johnson’s Baby Powder, Bandaids and Tylenol; prescription pharmaceuticals (39%), like drugs that treat Alzheimer’s syndrome, ADHD, depression and schizophrenia; and, thirdly, medical devices and diagnostics (40%), like stents and artificial joints. Key drivers management cites for future growth are its pharmaceuticals segment and the reinvigoration of its consumer products business. The prospects of new competition this for its blockbuster hepatitis C combination drug, Olysio/Savriad, are the big reason the stock faltered this month.

Accepting even the modest Wall Street outlook for JNJ top line growth, investors can expect solid total returns over the next five years. JNJ’s trailing 12-month PE as of today’s close was 19.5. Using  analysts’ consensus of EPS yearly growth of 7.1% over the next five years, and slapping on a slihglty lower trailing PE of 17.5 (JNJ’s 5-year median), the stock could reach $139 by 2019. With dividends reinvested, that comes to an average annual total return of 10.7%. That’s roughly equal to the S&P’s average over the past 80 years, which should please moderate-risk investors, especially considering that roughly a quarter of JNJ’s returns should come from its rising dividends.

About Lawrence Meyers
 lawrence meyersLarry is regarded as one of the nation’s experts on alternative consumer finance. He consults for hedge funds and private equity via his Council Member status at Gerson Lehman Group, and as a member of Coleman Research Group’s Executive Forum. He also consults for Credit Access Businesses and Credit Services Organizations in Texas. His Op-Eds and Letters to the Editor have appeared in over two dozen major newspapers. He also brokers financing, strategic investments, and distressed asset purchases between private equity firms and businesses of all stripes. You can reach him at [email protected]


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