May has been a firestorm of a month for me as far as purchasing equity is concerned. This shopping spree was due to a huge influx of disposable capital that fell into my lap thanks to some generous monetary gifts I received for my birthday from various family members, and also because I was able to free up a lot of savings I had accumulated for a home down-payment (yup, I’m house-hunting!) after I obtained a better loan offer with a much lower minimum down.
And so, after initiating a full position in Chevron last week, I once again deployed some capital just a few days later in yet another classic, blue-chip stock: Johnson & Johnson. I already owned 11 shares of the healthcare giant with a cost basis of roughly $1000, and with the ex-dividend date right around the corner, I figured now would be a good time to double down and make a full position out of it. On 5/20/2015 I purchased 9 shares of JNJ at $103.81/share, for a total investment of $934.29.
When deciding whether or not to buy a stock, I perform both a quantitative and qualitative analysis. All the data I use to calculate shit is pulled from Morningstar. So without further ado, let us first take a look at some of the numbers and ratios behind Johnson & Johnson.
When looking at a company’s revenue growth, I like to compute the compound annual growth rate over 10-year, 5-year, and 3-year periods. This allows me to see whether or not the business has been growing over time and it also shows me whether the growth has been accelerating or decelerating in recent years. Here’s a chart I created of Johnson & Johnson’s CAGR for those 3 time periods:
It looks like the company has seen a fairly consistent annualized revenue growth in the region of 4.5% over the last decade. There is a bit of a dip when looking at the 5-year CAGR, most likely due to the fact that revenue was a little flat in the 2-3 years that followed the recession. Overall, this definitely isn’t massive growth, but for a company that has been around since 1886 and that is as established as Johnson & Johnson, I find this kind of persistent revenue growth to actually be quite good.
EPS growth is another important metric to look at because it will give you a better picture of a company’s financial health. Revenue growth is nice and dandy, but if net income isn’t increasing proportionally, then there’s clearly something wrong going on. Here’s what Johnson & Johnson’s EPS CAGR looks like:
These are some interesting figures. While the 10-year and 5-year CAGRs seem to be inline with the respective revenue CAGRs, the 3-year EPS CAGR seems disproportionately high compared to the 3-year revenue CAGR. I’m not quite sure why there is such a discrepancy (not that I’m complaining!), though I suspect that it is due to the company’s increased share buybacks in the last 2 years, which reduced the shares outstanding from 2.83 billion in 2014 to 2.77 billion in 2015.
Return On Equity
I like to look at a company’s return on equity to get an idea of how much profit it generates with the money that shareholders invest in it. A really low ratio can be synonymous with low profitability and begs the question of what the hell the company is doing with our cash.
Johnson & Johnson boasted a very nice ROE of 22.7 in 2014, which is far above the industry average of 15.9. I’m not surprised by this number, as JNJ is a high-quality company renowned for its commitment to creating shareholder value (it is a dividend aristocrat with over half a century of consecutive dividend increases, after all).
The debt-to-equity ratio will tell you if a company has been using a lot of leverage to finance its growth. Acceptable numbers here will vary depending on the industry you’re dealing with, with some sectors like the financials sector being notorious for their high levels of debt. Johnson & Johnson’s debt-to-equity ratio registered at a tiny 0.22 in 2014, below the already low industry average of 0.4.
Interest Coverage Ratio
Another important ratio I like to look at is the interest coverage ratio, which you get by dividing a company’s earnings (before taxes, interest, rainbows, etc.) by its interest expenses. I usually like to see a number above 5 here, preferably even 10, though again this can vary significantly depending on the industry we’re dealing with.
Johnson & Johnson had an interest coverage ratio of 39.58 in 2014, which is excellent. Given this number and the low debt-to-equity ratio, it is clear that the company is led by a strong management team that is adept at managing the business’s debts and liabilities.
The yield currently hovers in the attractive vicinity of 2.8%, which is above the 2.5% minimum that I usually like to see (this if of course just a general rule of thumb, as I do own a few stocks with yields lower than that).
Johnson & Johnson’s payout ratio sat at 48.4% in 2014, which is quite modest and leaves the dividend plenty of room to grow for the foreseeable future.
Dividend Growth Rate
Dividend growth rate is one of the most important factors to look at as a dividend investor. Here are Johnson & Johnson’s 10-year, 5-year, and 3-year dividend CAGRs:
I like the numbers I’m seeing here. While it does look like the DGR has been decelerating in recent years, I’m still very impressed by these high single-digit numbers, especially for a company that has been increasing its dividend for over 50 consecutive years already and that is long past its days of massive growth. If Johnson & Johnson can keep its DGR in the 6%-8% range over the next decade, I’ll be very happy!
I used a DDM (Dividend Discount Model) with a discount rate of 10% and a dividend growth rate of 7% to valuate the stock. Since the company’s dividend growth rate has slowed down a bit in recent years, I decided to use the lower of the 3 CAGRs as my estimated dividend growth rate, hence the 7% in my model. This gives me a small margin of error while still retaining what I think is a feasible dividend growth rate for years to come.
Using these numbers, the fair value came out to $98.44, which means that I purchased the stock at a slight premium. While I obviously prefer to buy shares at fair or, better yet, discounted prices, in this case I felt like it wasn’t worth missing out on the upcoming dividend ex-date over a few dollars; if anything, the dividend will make up for the slight premium. Plus, Johnson & Johnson tends to always sell at fair prices/slight premiums anyway, and, in the long run, that small premium I paid will amount to nothing more than a rounding error (especially for such a small purchase of only 9 shares).
Johnson & Johnson is, quite simply, the king of healthcare, and a stock that I think belongs in any dividend investor’s portfolio. With my 20 shares of JNJ, I can now expect to receive roughly $60 in passive annual income from the company, which is pretty sweet! I will undoubtedly continue to add to my position over time, as this is a company I can easily see myself eventually owning hundreds of shares of, and I will continue to proudly wear superhero-themed band-aids until the day I draw my last breath (which will most likely be in a hospital room full of JNJ medical equipment).
What’s your opinion of JNJ? Do you consider it a “must-own” stock? Feel free to share your thoughts in the comments!
Disclosure: long JNJ