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Using the Value Line Page: Johnson & Johnson August 27, 2010
Johnson & Johnson (JNJ – Free Analyst Report) manufactures and sells health care products. Its major product lines include Consumer products (baby care, non-prescription drugs, sanitary protection, and skin care), Medical Devices and Diagnostic products (wound closures, minimally invasive surgical instruments, diagnostics, orthopedics, and contact lenses), and Pharmaceuticals (contraceptives, psychiatric, anti-infective, and dermatological drugs). As the Business Description shows, the breakdown of 2009 sales by segment was Pharmaceuticals 36%, Medical Devices and Diagnostics 38%, and Consumer Products 26%. International business accounted for about 50% of 2009 sales. (You can find a free copy of the page here to be used in conjunction with this article.)
Johnson & Johnson is one of the biggest names in the health care space, which has lately been out of favor on Wall Street. This has left the company’s share price in a sideways trend for several years, as can be seen on the Graph. Despite this sideways price movement, the company’s businesses continue to grow. This disconnect raises the possibility that Johnson & Johnson’s shares may be undervalued. Looking more closely at the Value Line page can help confirm or dispel this suspicion and help determine if the stock is a good buy or not.
The first item of note is that the shares have been trading below Value Line’s Cash Flow line since the beginning of 2007. The Cash Flow line plots a valuation level relative to cash flow that best fits the company’s graph. In short, similar to a Price to Earnings (P/E) multiple, it provides a sense of how the market has valued a company’s shares over time. That Johnson & Johnson is trading well below its Cash Flow line suggests the price may be too low. Also on the graph, the dotted line shows the relative price strength of the shares compared to the broader universe of 1,700 companies that Value Line follows. Interestingly, the company’s less risky profile allowed it to show a great deal of relative strength throughout 2008 and early in 2009, but that trend reversed with the shares showing generally weak relative strength since the end of the first quarter in 2009.
Further, Johnson & Johnson’s Relative P/E, which can be found to the right of the name in the Top Label, is 0.85. This shows that it is trading at a relatively low price relative to the broader market. Further, the current P/E, found in the box just to the left of the Relative P/E, is 12.4, which is well below the 18.0 Median P/E for the company over the long term. All told, the Cash Flow line, the relative price strength, and the P/E all suggest that the company is trading at a relatively cheap price.
Reviewing the historical figures in the Data Array, meanwhile, gives an even deeper picture of the company’s current valuation. The Relative P/E, for example, was well above 1.00 (above the broader market’s valuation) between 1995 and 2003, often dramatically so. Since 2004, the shares have traded at lower valuation levels, with the current level near the low point. As the data show, the P/E, too, is currently near a low point since 1994. Again, it appears that, historically speaking, Johnson & Johnson shares are inexpensive.
The shares trading below the Cash Flow line, the weak relative strength, the bargain pricing based on P/E multiples are all interesting when compared against corporate performance. The company’s earnings have gone up every year since 1994—a period that includes two recessions. As the Annual Rates box on the left hand side of the page shows, earnings have increased at a 12.5% annualized clip over the past 10 years. Although this growth slowed some to 10.5% over the past five years, that doesn’t seem enough to justify a reduction in relative P/E from 1.80 in 1999 to 0.96 in 2004 to 0.83 in 2009.
Dividends have followed the same upward path as earnings, rising every year. Over the trailing five- and 10-year periods, the rate of increase has handily outpaced inflation. Interestingly, here, too, the stock appears to be trading at a bargain level, as the dividend yield (which can be found in the Top Label) is at the high end of its historical range (which can be found in the Data Array), approaching 4%. With the average annual dividend yield touching a low of 1.2% in 1999 (coinciding with the highest valuation levels afforded the company’s shares in terms of P/E multiple and relative P/E), the current level seems particularly generous. It also happens to be over a full percentage point above the average of all dividend paying companies Value Line tracks (this average, 2.2%, can be found each week on the cover of the Ratings & Reports section). True, dividends as a percentage of net profits has increased over the years, but earnings still handily cover the payout.
Although recent historical earnings trends don’t seem to justify the current low price of Johnson & Johnson shares, the stock market often looks to the future and not the past. On that front, Value Line analyst David Cohen is expecting a slowdown, with earnings growth over the coming three to five years pulling back to the high single digits. The question is whether this reduced level of earnings growth justifies the reduced valuation observed above.
As the Analyst Comment points out, however, slowing earnings growth isn’t the only negative, as recent product recalls have taken a toll on earnings and the company’s image. This isn’t the first time Johnson & Johnson has dealt with product recalls, however, so it is likely to deal expediently with the issue. More important, however, it has the financial wherewithal to do so with a current ratio well above 1.0. (You derive the current ratio by dividing the company’s current assets by its current liabilities, which can be found in the Current Position Box on the middle left of the page.) Note, too, that the company has well over $18 billion of cash on the balance sheet (which can also be found in the Current Position Box). In fact, it has more cash on its balance sheet than it has debt. The total debt figure of $11.65 billion can be found in the Capital Structure Box just above the Current Position information.
These fundamental statistics underscore Value Line’s awarding the shares a top notch Safety Rank (founding the Rankings Box at the top left of the page) and Financial Strength Rating (found in the Ratings Box at the lower right of the page). Johnson & Johnson’s solid financial stance has been beneficial not only in dealing with the product recalls, but also in funding acquisitions which promise to extend its product offerings and help it gain exposure to fast-growing healthcare segments. (The Analyst Comment outlines some recent purchases.)
All told, Value Line’s longer-term projection is for Johnson & Johnson shares to appreciate to about $105 a share in three to five years (the range of $95 to $120 per share can be found in the Projections Box and is visually displayed by the two dotted lines on the far right of the graph). Including dividends in the mix suggests an annualized total return somewhere between 16% and 22%. Trading at a low valuation, with moderating but still solid earnings prospects, and a strong financial position from which to build, Johnson & Johnson shares seem a solid choice for conservative investors.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.