Updated on July 5th, 2019 by Bob Ciura
Health care giant Johnson & Johnson (JNJ) is one of the most highly-regarded dividend growth stocks of all time. This reputation is well-earned, as Johnson & Johnson has increased its dividend for 57 years in a row.
It is a member of the Dividend Aristocrats, a group of 57 stocks in the S&P 500 Index with at least 25 years of annual dividend increases.
The Dividend Aristocrats are the ‘cream of the crop’ when it comes to dividend growth stocks.
The requirements to be a Dividend Aristocrat are:
- Be in the S&P 500
- Have 25+ consecutive years of dividend increases
- Meet certain minimum size & liquidity requirements
There are currently just 57 Dividend Aristocrats. You can download an Excel spreadsheet of all 57 (with metrics that matter) by clicking the link below:
Johnson & Johnson is also part of the even more exclusive list of Dividend Kings, a group of just 24 stocks that have increased their dividends for 50+ consecutive years.
Johnson & Johnson’s impressive dividend history is due to its highly profitable, global business that has generated steady growth for the past several decades. Going forward, Johnson & Johnson has plenty of growth opportunities ahead in the U.S. and the international markets.
Johnson & Johnson stock has a nearly 3% dividend yield and should continue to increase its dividend each year for the foreseeable future.
Johnson & Johnson was founded in 1886 by three brothers: Robert, James, and Edward Johnson. Today, the company employs more than 125,000 people around the world. The stock has a market cap of $373 billion, making it a mega-cap stock, meaning it has a market capitalization above $200 billion.
Its business model is spread across three categories, pharmaceuticals (~49% of sales), medical devices (~34% of sales) and consumer products (~17% of sales). Johnson & Johnson has a leadership position in all three segments.
Johnson & Johnson’s diversified business model provides multiple advantages. Pharmaceuticals offer the highest growth potential, but results can be volatile based on the success or failure of drug launches. Meanwhile, consumer healthcare products are far more stable, albeit with less growth potential. Still, Johnson & Johnson’s consumer franchise includes many strong brands that offer stable growth, such as Listerine, Neutrogena, Tylenol, and more.
Source: 2019 CAGNY Presentation
Johnson & Johnson has experienced elevated risk in recent months due to a report of possible contaminants in its talc powder. There are approximately 12,000 product liability lawsuits related to its baby powder. There is risk of a large financial penalty, but Johnson & Johnson maintains that its talc powder has not caused cancer. More recently, Johnson & Johnson is a defendant in a court case in Oklahoma pertaining to the company’s role in the opioid crisis in that state.
These lingering legal issues have resulted in heighted regulatory and headline risk facing the stock. Investors could see elevated volatility in the share price over the near-term as a result. However, our view of the company’s long-term outlook remains unchanged. Johnson & Johnson may face significant financial penalties from the various lawsuits, but we do not expect any permanent impairment to the company or its business model.
The long-term fundamentals of the company should remain intact, and in the meantime the company is still generating growth. J&J had adjusted earnings-per-share of $8.18 in 2018, which represented 12.1% growth from the previous year.
Organic revenue increased 5.5% for 2018, led by the pharmaceutical segment which posted double-digit growth for the year, far outpacing the medical devices and consumer segments.
Source: Earnings Presentation
Johnson & Johnson gave a strong performance in the most recent quarter as well. In the first quarter, revenue of $20 billion was flat from the year-ago quarter, but did beat analyst expectations. Earnings-per-share of $2.10 rose 2% year-over-year, and exceeded analyst estimates.
The medical devices business was the worst performer in the first quarter, with sales down nearly 5% largely due to falling orthopedics sales. Johnson & Johnson has faced immense competitive pressure from Stryker Corporation (SYK) in the area of knee replacements.
Consumer revenues dropped 2.4% to $3.3 billion as gains in Beauty and Over-the-Counter were more than offset by declines in Oral Care, Women’s Health and Baby Care.
Fortunately, the pharmaceutical segment paved the way for Johnson & Johnson’s growth last quarter, and is expected to continue doing so in the years ahead.
Johnson & Johnson has invested aggressively in its pharmaceutical business, due to the tremendous growth potential in these products. It has made these investments both organically and through acquisitions. Johnson & Johnson has spent heavily on acquiring companies that fit with its business model. One example is the company’s $30 billion all-cash purchase of Actelion, which is already contributing to earnings.
In addition, Johnson & Johnson spends aggressively on research and development to further build out its own pipeline of future products. Johnson & Johnson had research and development expense of $10.77 billion in 2018, the second year in a row of R&D expense above $10 billion. This is surely an enormous sum of cash, but it is imperative for pharmaceutical manufacturers to invest sufficiently in building its future product pipeline.
The fundamentals of the healthcare sector are positive. Major healthcare stocks such as Johnson & Johnson are likely to benefit from the sustained tailwind of the aging population. The U.S. is an aging population. The Baby Boomers are a large generation, totaling over 70 million, with thousands of people entering retirement every day. As a result, healthcare spending is expected to continue rising at a faster rate than GDP in the United States. The U.S. Centers for Medicare & Medicaid Services expects U.S. healthcare spending to rise at a 5.5% annual rate over the next 10 years.
The primary growth catalyst for the healthcare industry is new pharmaceutical products. Whereas Johnson & Johnson’s consumer and medical device segments grew revenue by 2% and 1% last year, its pharmaceutical segment grew revenue by 12% in 2018.
Consumer products and medical devices are generally slower-growth in nature, while pharmaceutical products are the major drivers of growth. Within its pharmaceutical segment, the best-performing areas continue to be oncology and immunology.
Oncology sales rose by nearly 25% in constant currency last year, while the immunology segment grew by 10% in 2018. In oncology, multiple myeloma drug Darzalek grew by more than 60%. Another winner is Imbruvica, which grew revenues by more than 38%.
As in 2018, Johnson & Johnson’s pharmaceutical segment was also the primary driver of growth in the 2019 first quarter. Pharmaceutical revenue grew 4.1% to $10.2 billion in the most recent quarter. Revenue for Immunology grew 6.9% while Oncology improved 9%. Stelara, which treats immune-mediated inflammatory diseases and is Johnson & Johnson’s top selling product, had sales growth of 36%. Revenues for Darzalex, treatment for multiple myeloma, improved 46%.
Johnson & Johnson’s pharmaceutical pipeline is a long-term growth catalyst. The company has a robust pipeline of new products. Its portfolio includes 26 platforms or products with over $1 billion in annual sales.
Source: Earnings Presentation
Aside from pharmaceuticals, the emerging markets are an additional growth catalyst for Johnson & Johnson over the long-term. Developing economies in Asia, the Middle East, and Africa have high rates of economic growth, and large populations, making them ideal areas of expansion for Johnson & Johnson.
Indeed, in 2018 the company generated 7.7% international revenue growth in constant currency, including 9.4% growth in the company’s Asia-Pacific/Africa segment. These regions outperformed the U.S., which grew at a 5.1% rate last year.
International growth once again outpaced that of the U.S. in the first quarter. Johnson & Johnson grew revenue by just 1.8% in the U.S. last quarter, compared with a 6% increase in the international markets. Revenue grew 4.5% in Europe, 6.9% in Asia-Pacific/Africa, and 8.7% in the Western Hemisphere (excluding the U.S.) in the 2019 first quarter.
Lastly, share buybacks will help boost future EPS growth. In December, the company announced a share repurchase program of up to $5.0 billion of its common stock. Share repurchases help accelerate EPS growth, by reducing the number of shares outstanding. With each share bought back by the company, every remaining share receives a higher portion of the company’s earnings.
Johnson & Johnson reiterated its revenue guidance of $80.4 billion to $81.2 billion, but tightened its earnings-per-share expectations to a range of $8.53 to $8.63. The midpoint for earnings-per-share guidance remains unchanged at $8.58, and so has our estimate for 2019.
Valuation & Expected Returns
We expect Johnson & Johnson to generate earnings-per-share of $8.58 in 2019. Based on this, the stock has a current price-to-earnings ratio of 16.4x. This is above the 10-year average price-to-earnings ratio of 15.8x. Our fair value estimate for Johnson & Johnson stock is equal to the 10-year historical average.
Therefore, we believe the stock is slightly overvalued today. A contracting P/E ratio to our fair value estimate would reduce annual returns by 0.7% per year over the next five years.
However, just because Johnson & Johnson stock is slightly overvalued, does not necessarily mean it will be a bad investment. Such high-quality companies as Johnson & Johnson deserve slightly higher valuation multiples, for their steady and predictable earnings growth and strong dividends.
We forecast 6% annual EPS growth for Johnson & Johnson through 2024, comprised of revenue growth and share repurchases. In addition, the company currently pays an annual dividend of $3.80, representing a 2.7% dividend yield. This is an attractive yield, as the S&P 500 Index on average yields just ~2% right now.
Overall, we expect total returns of 8.0% per year over the next five years. While we do not view the stock as a compelling buy right now, on the basis of valuation, it is a strong hold for its dividend and reliable dividend increases.
Johnson & Johnson recently increased its dividend by 5.6%, and should continue to raise its dividend each year for the foreseeable future. The company has an expected dividend payout ratio of 42% for 2019, meaning the dividend is highly secure. The following video clip discusses our view of the company’s dividend safety in further detail.
Johnson & Johnson’s dividend is one of the most appealing parts of owning shares in the company. Johnson & Johnson is a good mix of dividend yield and growth and has increased its dividend for 57 years in a row, including the recent 5.6% increase.
The company should have little trouble raising its dividend in the years ahead. It has a positive outlook for future growth, a modest payout ratio, and an excellent balance sheet. Johnson & Johnson is one of just two U.S. stocks with a top credit rating of AAA from Standard & Poor’s, the other being technology giant Microsoft Corporation (MSFT).
Another factor augmenting Johnson & Johnson’s dividend safety is its recession-resistant business. The company remains highly profitable even during recessions, thanks to the necessity of its product offerings. While consumers can cut back on discretionary purchases when times are tight, the same often cannot be said about healthcare products. This is what fueled Johnson & Johnson’s strong financial performance during the Great Recession of 2007-2009. Earnings-per-share during the Great Recession are below:
- 2007 earnings-per-share of $4.15
- 2008 earnings-per-share of $4.57 (10% increase)
- 2009 earnings-per-share of $4.63 (1% increase)
- 2010 earnings-per-share of $4.76 (3% increase)
As you can see, the company increased earnings in each year of the recession. This helped it continue raising its dividend each year, even though the U.S. entered a steep economic downturn. Johnson & Johnson should keep paying its dividend, and raising its payout each year, even if a recession occurs in the near future.
Johnson & Johnson stock faces a higher level of risk right now than investors are accustomed to, due to the various lawsuits. This could keep a lid on the stock valuation in the years ahead. Indeed, we view the stock as slightly overvalued right now.
That said, Johnson & Johnson is one of the highest-quality businesses in the entire S&P 500 Index. It has a highly profitable business model, durable competitive advantages, and a positive long-term growth outlook in the U.S. and especially the international markets. It also has an excellent balance sheet which gives it the financial strength to invest in growth opportunities.
The only downside to Johnson & Johnson stock right now is its valuation. The stock is not considerably undervalued, which is why we maintain a hold rating on the shares. However, any meaningful decline in Johnson & Johnson’s share price would be a welcome buying opportunity for investors sitting on the sidelines.
For current shareholders, Johnson & Johnson will continue to pay its attractive dividend and raise the dividend each year for many years.