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There are signs J&J has put the worst behind it and is embarking on a new phase of growth. (JB REED/BLOOMBERG NEWS)
There are signs J&J has put the worst behind it and is embarking on a new phase of growth. (JB REED/BLOOMBERG NEWS)

Strategy Lab

Five reasons to like Johnson & Johnson Add to ...

John Heinzl is the dividend investor for Globe Investor’s Strategy Lab. Follow his contributions here. You can see his model portfolio here.

Johnson & Johnson has made headlines over the past couple of years – for all the wrong reasons. Plagued by quality control problems and costly product recalls affecting key brands such as Tylenol, Benadryl and Motrin, the health care giant’s reputation has taken a huge hit.

So have its earnings, which plunged 27 per cent in 2011, hurt by recall costs in J&J’s consumer segment and litigation expenses in its pharmaceutical and medical devices divisions. Yet there are signs J&J has put the worst behind it and is embarking on a new phase of growth. The stock is up 11 per cent this year, including dividends, and analysts – nearly two-thirds of whom have a “buy” on the shares – say there’s more upside ahead. Here are five reasons to like J&J.

1. It’s a dividend machine

Even as it strives to correct problems that led to the recalls, J&J still churns out enormous amounts of cash that it can use to reward shareholders. In April, it hiked its dividend by 7 per cent – the 50th consecutive annual increase. Thanks to its strong cash generation and rock-solid balance sheet – it’s one of the few companies with a triple-A credit rating – J&J is expected to raise its dividend at a similar rate for years to come. The current yield of 3.4 per cent is also attractive.

2. It’s diversified

J&J is actually three health care companies in one, with separate divisions that focus on over-the-counter consumer products (about 23 per cent of sales), pharmaceuticals (37 per cent) and medical devices and diagnostics (40 per cent). As such, a slowdown in one division can be made up by growth in another. That was evident in the third quarter, as higher sales of prescriptions and medical devices offset a decline in the consumer segment.

3. It has demographics on its side

Because older consumers spend more on health care, J&J stands to benefit from the greying of the population. “The over-60 age group will be one of the fastest-growing age groups over the next couple of decades, and utilization of health care products such as prescription drugs and devices increases with age,” analyst Linda Bannister of Edward Jones, who has a “buy” on J&J, said in a note. Globally, she expects sales of pharmaceuticals and medical devices to grow by 4 to 6 per cent annually, providing a “tailwind for the health care industry in general.”

4. Its growth is accelerating

In the third quarter, J&J’s global prescription drug sales jumped by 7 per cent, lifted by new products such as Zytiga for prostate cancer, Incivo for hepatitis C and Stelara for psoriasis. That compared with prescription sales growth of less than 1 per cent in the second quarter. Sales of medical devices surged 12.5 per cent, boosted by the recent acquisition of Synthes Inc., which makes a wide range of orthopedic implants and other products. Device sales had fallen 0.1 per cent in the second quarter. “We continue to see improving fundamentals at J&J across all of its segments,” wrote Sanford Bernstein analyst Derrick Sung, who rates J&J “outperform.”

5. It’s reasonably priced

J&J trades at a multiple of about 14 times estimated 2012 earnings – well below its average price-to-earnings ratio of about 20 since 1980. Granted the P/E has been moving higher recently – it got as low as 11.6 in 2009 – but given the attractive dividend yield, J&J’s solid dividend growth potential and the company’s improving sales and earnings, the stock price seems reasonable. As Value Line analyst Erik Antonson said in an August report: “This top quality blue chip remains an excellent choice for buy-and-hold investors.”

Disclosure: The writer owns shares of Johnson & Johnson.

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