Pharmaceutical drug, medical device, and general healthcare conglomerate Johnson & Johnson (JNJ) is one of the most revered dividend growth stocks in existence. The company has increased its dividend a staggering 58 years in a row. Johnson & Johnson boasts incredibly strong fundamentals that make it a safe long-term investment and dividend growth portfolio bedrock. However, with the market at all-time highs, the share price is at a similar level. When you factor in the modest growth of this mature enterprise, the immediate upside of the stock is a bit more questionable than the company’s strong fundamentals.
Undeniable Fundamentals Deliver Safety To Investors
Let’s lay the foundation for our discussion further down in this article by walking through a discussion of how Johnson & Johnson is one of the safest stocks out there. The company’s reliability as an investment is derived from three core attributes: its diversity, profitability, and the balance sheet.
Johnson & Johnson is a healthcare conglomerate. So first, you are dealing with a company that operates in a crucial healthcare space. As populations age and technology advances in how we care for our sick and elderly, the demand for healthcare will be ongoing. On top of this steady demand, you have Johnson & Johnson’s immense diversity within the space. The company is split into three major areas of care, including pharmaceuticals, medical devices, and consumer products. It sells 26 platforms or product brands with at least $1 billion in annual sales, and these are sold all over the world.
(Source: Johnson & Johnson)
All of this adds up to steady, reliable performance. Regardless of the economic environment, Johnson & Johnson has been able to produce for decades. This consistency has enabled the company to raise its dividend every year like clockwork.
A steady business is a good asset for investors, but what separates JNJ from many other businesses is the high level that it consistently produces at.
The company is consistently generating tons of free cash flow, with roughly 24% of all revenues ending up as free cash flow. This consistently high level of profitability gives Johnson & Johnson a lot of financial flexibility to raise dividends and pursue acquisitions that continuously augment and reshape its business portfolio.
Lastly, Johnson & Johnson boasts a culture of excellent management. The company is effective at creating value for its investors, with a rate of return on invested capital of 17%. Additionally, the company avoids abusing its balance sheet.
Using gross debt, Johnson & Johnson is only levered at 1.2X EBITDA, and that is before factoring in the $11 billion that it holds in cash and equivalents. The company boasts a triple A rating on its debt, making JNJ more creditworthy than the US government (my favorite stat about JNJ). When you have a business that is so consistent and performs at such a high level while maintaining strict financial discipline, it makes for a remarkably safe company to invest in.
Upside Is A Bit More Questionable
Where things get a little more uncertain is when we shift our focus to what the current upside is for investors. While Johnson & Johnson has a very solid “floor” thanks to its resounding quality, the company is very mature and hasn’t been growing that rapidly in recent years.
Revenue growth over the previous decade has been in the low- to mid-single digits, and EPS growth has paced similar to that. With a $400 billion market cap and $80 billion in annual sales, the “needle” is harder to move than it used to be.
Johnson & Johnson is always “tweaking” its business, and it just recently announced a $6.5 billion acquisition of Momenta Pharmaceuticals (MNTA). The acquisition will help bolster JNJ’s pharmaceutical pipeline (its largest business segment), but overall, the growth outlook of the company is pretty “slow and steady” at the moment. Over the upcoming five-year stretch, analyst projections are forecasting EPS growth at roughly 5% per year.
Again, this isn’t about JNJ’s quality as a company to invest in. This is about its growth prospects, and what that means for investors moving forward. If we ignore 2020 because of COVID-19 and look at estimated 2021 earnings, JNJ is slated to earn approximately $9 per share.
This would result in an earnings multiple of 16.8X on a forward basis. This is right in line with the company’s five-year average forward multiple. Based on Johnson & Johnson’s modest growth, I would argue that we are within shouting distance of “fair value”, and I wouldn’t expect drastic multiple expansion from these levels.
Where Do Shares Make Sense?
Whether the quality of the business deserves a premium is up to the investor (as well as the degree of the premium). But if we assume that JNJ stock appreciates organically from here, we are looking at total returns in the 7-8% per year range. Not a bad return by any means, but we are simply striving to perform with the broader market at this rate.
Investing at a discounted valuation would allow for a margin of safety. It can be difficult for a top-of-the-line blue chip such as JNJ to fall drastically below its historical multiples, but if the stock fell 15%, it would put the shares in a little better position for investors. This would mean a price of $128 per share, still comfortably within its 52-week range. It’s hard to go wrong buying Johnson & Johnson. But for investors looking for a high degree of wealth generation, the stock price needs some breathing room.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.