Johnson & Johnson (NYSE:JNJ), together with its subsidiaries, is engaged in the research and development, manufacture, and sale of various products in the health care field worldwide. The company operates in three segments: Consumer, Pharmaceutical, and Medical Devices & Diagnostics. This dividend king has paid dividends since 1944 and has managed to increase them for 54 years in a row. Dividend increases have been like clockwork every year for decades.
The company's latest dividend increase was announced in April 2016 when the Board of Directors approved a 6.70% increase in the quarterly dividend to 80 cents /share. The company's peer group includes Novartis (NYSE:NVS), Pfizer (NYSE:PFE) and Roche Holdings (RHHBY).
Over the past decade this dividend growth stock has delivered an annualized total return of 9.70% to its shareholders.
The company has managed to deliver 4.70% average increase in annual EPS over the past decade, which was slower than the rate of dividend growth. Johnson & Johnson is expected to earn $6.59 per share in 2016 and $7 per share in 2017. In comparison, the company earned $5.48/share in 2015.
Johnson & Johnson also has managed to reduce number of shares outstanding. Between 2006 and 2016, the number of shares declined from 2,963 million to 2,795 million.
Johnson & Johnson has a diversified product line across medical devices, consumer products and drugs, which should serve it well in the future. This makes the company somewhat immune from economic cycles. Investors looking for a safe and dependable earnings, can look no further than Johnson & Johnson. In addition, the company has strong competitive advantages due to its scale, leadership role in various diverse healthcare segments, breadth of product offerings in its global distributions channels, continued investment in R&D, high switching costs to users of its medical devices, as well as its stable financial position.
The ability to generate strong cash flows, have enabled Johnson & Johnson to reward shareholders with a higher dividends for 54 consecutive years.
Future profits growth could come from new product offerings, which are the result of continued investment in research and development, and through strategic acquisitions. The company spends approximately 11% - 12% of sales on Research & development. Newer drugs like Xarelto, Imbruvica, Invokana could offset potential losses in sales in drugs whose patents expire, and could fuel sales growth for the company. Johnson & Johnson is also constantly trying to use its advantages of scale to achieve efficiencies and generate as much as $1 billion in operational savings by 2018.
Johnson & Johnson is also expanding its business through strategic acquisitions. For example, the acquisition of Synthes, made it a leader in fast growing trauma market. This also allowed the company to use its overseas cash without having to pay the steep repatriation taxes. Emerging market growth and opportunities for cost restructurings should further help the company in squeezing out extra profits in the long run. The company is sitting on $38 billion in cash and cash equivalents, which could provide the fuel behind further accretive acquisitions.
The fact that the company has exposure to other healthcare segments besides pharmaceuticals makes it a much safer play on the healthcare sector than pure pharma companies. I like the fact that there is diversity in the revenue generating behind each of the large segments. The three segments include Pharmaceutical with 45% of sales, Medical Devices & diagnostics with 36% of sales and the Consumer segment with approximately 19% of sales.
The company’s Consumer segment has strong brand names. The Medical Devices & Diagnostics segment has high switching costs, since it would take a medical professional weeks to learn some of the products of a competitor and thus would increase the hassle factor for this professional. The pharmaceuticals segment has patent protection on several key drugs. Even for those whose patents will expire soon, it may be difficult for competitors to replicate them, which slows down the impact of generic competition. This diversity insulates the company against patent losses. The other positive is that no one product accounts for a substantial portion of each segments revenues.
The annual dividend payment has increased by 8.70% per year over the past decade, which is higher than the growth in EPS.
A 9% growth in distributions translates into the dividend payment doubling every eight years on average. If we check the dividend history, going as far back as 1974, we could see that Johnson & Johnson has actually managed to double dividends almost every five and a half years on average.
In the past decade, the dividend payout ratio increased from 39.10% in 2006 to a high of 64.50% in 2011, and is now at 53.80%. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.
The return on equity has decreased from 29% in 2004 to 22.70% in 2014. This is still a very high return on equity however. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time. Given the fact that the amounts in this indicator are still high these days, I do not view this decline as a major warning sign.
Currently, the stock is attractively valued at 17.10 times forward earnings and a current yield of 2.80%. Using the 2015 earnings per share of $5.48, the stock seems right at the top of the valuation I am willing to pay for a company like Johnson & Johnson. The only reason I am hesitating to add more shares is because the company is one of my five largest portfolio holdings.
Full Disclosure: Long JNJ
- My Five Largest Dividend Portfolio Holdings for the Long Term
- My Entry Criteria for Dividend Stocks
- Ten Dividend Growth Stocks That Keep Delivering For Their Shareholders
- Dividend Kings for 2016
- How to value dividend stocks
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