John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.
In December, I sold my McDonald's shares, both personally and in my Strategy Lab model dividend portfolio. The burger giant's same-store sales have been sliding, and it's far from certain that the Golden Arches' turnaround plans will reverse the damage given the intense competition McDonald's is facing. (Read my column on McDonald's.) Today, I'm unveiling the newest member of my Strategy Lab portfolio: Johnson & Johnson.
I've written favourably about J&J several times and I've owned the stock personally for years. Although I'm a bit nervous about adding to my U.S. exposure with the Canadian dollar trading at less than 81 cents (U.S.), I'm willing to live with some currency risk given the many strengths that J&J brings to the table. (View my model portfolio).
So, with the proceeds of my McDonald's sale, I'm purchasing 40 shares of J&J. Here are six reasons I consider J&J an attractive pick for buy-and-hold investors:
It's a dividend machine
J&J has one of the longest dividend growth records around, having raised its payment for 52 consecutive years. Its dividend hikes are also highly predictable, with increases usually announced in April. Although the current yield of about 2.7 per cent may seem modest, over the past five years the dividend has grown by 7.4 per cent on an annualized basis. Given J&J's conservative payout ratio of about 47 per cent of earnings, growing free cash flow and solid balance sheet – it's one of a few companies with a triple-A credit rating – analysts expect similar growth to continue in the years ahead.
It's produced impressive total returns
Dividends are just one component of an investor's return. Capital growth is also critical, and J&J has delivered on that as well. For the 10 years to Dec. 31, 2014, the stock generated a total return – assuming all dividends were reinvested – of about 121 per cent, or 8.3 per cent on an annualized basis. That compares with a 10-year total return of 109 per cent, or 7.7 per cent annualized, for the S&P 500 index. It's worth noting that this period included massive product recalls and plant closures that depressed J&J's stock for years.
It's diversified
J&J is really three health-care companies in one, with divisions that focus on pharmaceuticals (43 per cent of 2014 sales), medical devices and diagnostic equipment (37 per cent) and over-the-counter consumer health products (20 per cent). It's also geographically diverse, with more than half of sales coming from outside the United States, and about one-fifth from emerging markets that offer greater potential for growth. J&J's diversification is one reason the company has been able to post 31 consecutive years of growth in adjusted earnings. One downside of being diversified globally is that currency volatility can dampen results, which is precisely what happened in the fourth quarter because of the strong U.S. dollar, but such things are beyond J&J's control and at other times currencies can work in the company's favour.
It has demographics on its side
As people live longer and baby boomers age, demand will increase for the prescription drugs and medical devices that J&J produces. "Favourable demographic trends … should provide a tailwind for the health-care industry in general," Ashtyn Evans, an analyst with Edward Jones, said in a recent note. "Additionally, health-care spending in emerging markets is projected to rise as these countries become wealthier and look to become healthier."
It's growing
To capitalize on growing demand for health care, J&J is constantly developing new products: Since 2009, for example, it has launched 14 new drugs that have generated cumulative sales of more than $27-billion (U.S.), with dozens more now in late-stage clinical trials. "We are confident that JNJ is going to be one of the fastest-growing drug companies over the next three years, led by the recent launch of new pipeline assets," RBC Dominion Securities analyst Glenn Novarro said in a recent note. The medical devices and consumer businesses are also preparing to roll out myriad new products. "We have an exciting and deep product pipeline across the entire enterprise," J&J chief executive officer Alex Gorsky said on the fourth-quarter conference call.
The valuation is reasonable
J&J trades at about 16.4 times estimated earnings of $6.21 a share for the current fiscal year, earnings that would mark a 4-per-cent increase from adjusted earnings of $5.97 in 2014. The price-to-earnings multiple is roughly in line with J&J's peers but attractive given the company's diversified portfolio and growth potential from new products, said Ms. Evans, who rates the stock a "buy." Wall Street is generally positive on the shares: Of the 26 analysts who follow the company, there are 14 "buys," 11 "holds" and one "sell."
Closing thoughts
No company is risk-free. Currency movements, the failure of new products to live up to expectations, legal liabilities and health-care cost-cutting by insurers and governments could all negatively affect J&J. However, the company has successfully navigated through such issues before and over the long run it will almost certainly continue to post higher sales and profits and pay rising dividends to shareholders. Be sure to do your own due diligence before investing in any security.
John Heinzl