Why Johnson & Johnson (JNJ) is a Safe Stock Pick

Earlier this year, we highlighted Johnson & Johnson (JNJ) as a safe stock pick in a dangerous market. Our forecast proved to be correct as the stock beat the market and has rallied 11% since our article, while the S&P 500 has risen only 8%.

One of the main points of our investment thesis was the incredible diversification of Johnson & Johnson’s global growth opportunities. Earlier this week, the company announced that it was capitalizing on those growth opportunities by expanding into the pharmaceutical market of the world’s largest economy: China. Let’s discuss why now is the perfect time to invest in Johnson & Johnson.

How to Spot a Great Company in a Dangerous Market

Johnson & Johnson has a track record of profitability that very few companies can match. The company has an impressive return on invested capital (ROIC) of 15%, which puts it in the top tier of all companies I cover. It has also grown after-tax profit (NOPAT) by 10% compounded annually for the past 15 years. This kind of performance makes Johnson & Johnson a rock-solid investment.

Part of the reason Johnson & Johnson is so solid is its many product lines. If a particular product struggles, it is just a drop in the bucket and the company’s other offerings will pick up the slack. This is also the same company that sells staple products like Tylenol and Band-Aids that will always be in demand. Johnson & Johnson’s medical devices and pharmaceuticals divisions will also benefit from the needs of a generally older U.S. population.

What Does a Steady Cash Flow Mean?

As a result of this company’s great product streams, it is a cash flow machine. Last year, Johnson & Johnson had free cash flow (FCF) of over $14 billion. This steady cash flow from the company’s vast product portfolio has freed the company to experiment with high-growth ventures. Aside from Johnson & Johnson’s future investments in China, the company has been investing in high-growth biotech companies like Alector, which is aiming to combat dementia and Alzheimer’s.

Figure 1 shows just how stable and profitable Johnson & Johnson has been over the past 15 years.

Figure 1: Diversification Leads to Stability



Sources: New Constructs, LLC and company filings

Stock Pick: Why $109 is a Great Price to Buy JNJ

With its recent announcement, Johnson & Johnson has shown that it is still aggressively pursuing growth opportunities. However, the company is currently valued for minimal profit growth, which creates an excellent buying opportunity for value-minded investors.

JNJ’s current price of $109/share gives the company a price to economic book value (PEBV) ratio of 1.2. This number implies that the company will grow profits by just 20% for the remainder of its corporate life.

Remember that this is the company that has grown profits at a rate of 10% per year for the past 15 years. Johnson & Johnson will almost certainly surpass the expectations embedded in its current share price, especially with the future addition of another enormous market for pharmaceuticals.

JNJ has very limited downside potential, and excellent upside potential due to a number of factors, not least of which is the company’s expansion in to China. In our April report, we predicted that the company would beat earnings in the coming quarters. That is exactly what happened in the second and third quarters of this year, and we think investors can look forward to more even upside from this stock and another earnings beat within the next few months.

Value Investing, Buffett Style

As Warren Buffett has said, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” JNJ presents a prime opportunity to buy a truly wonderful company at a more-than-fair price.

André Rouillard contributed to this report.

Disclosure: David Trainer owns JNJ. David Trainer and André Rouillard receive no compensation to write about any specific stock, sector or theme.

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