Years ago, as I began my career as an investor, I read a book by Peter Lynch. Mr. Lynch had made his name, and his fortune, as the manager of Fidelity’s flagship Magellan fund in the late 70’s and ’80’s, and his incredible performance was one of the big reasons Magellan, at the time, was the largest mutual fund in America, with $14 billion in assets under management. The fund averaged an annual return of more than 29% while under his leadership, making it the top-performing fund in the world.
Shortly before retiring from the fund, Mr. Lynch wrote the book I was reading, One Up on Wall Street, in which he described the method he applied to the Magellan fund. I was surprised to see how he started simple, and much of what I learned from that book still plays a role in what I do today. Lynch popularized the idea of the “local economy,” meaning that often the best investment opportunities can be found not just within your own respective region or part of the world, but even within arm’s reach.
Finding investments at arm’s reach means recognizing the products that you, as a consumer, make use of on a regular, even daily basis. If you’re like me, most of the time, you don’t think about these items very much at all – when I go to the grocery or department store for the week with my wife, we have a list of items that we always need to have on hand, so there are certain parts of the store we always go through. Personal hygiene – shampoo, soap, toothpaste, deodorant, lotion, vitamins – check. Cleaning supplies – laundry soap, dish soap, window cleaner, surface wipes – check. Mr. Lynch helped me realize that the companies behind these products that have become a normal part of my home can also make good investing opportunities.
Sometimes broad national and even global conditions shift the market’s attention into a specific sector of the economy or even to specific industries on a larger-than-normal scale. I think it’s safe to say that is where we are today; with COVID-19 news dominating the airwaves in just about every media outlet, one of the biggest questions the entire world is grappling with revolves around finding ways to treat and ultimately eradicate a novel (meaning, completely new) virus. In the short term, that means finding antiviral drugs to treat the worst symptoms and see people through as the human immune system fights the virus. In the long term, that means developing vaccines that provide antibodies to strengthen the immune system and make it more resistant to infection.
The market’s focus over the last month on COVID-19 has put the entire Healthcare sector into sharp focus, and it’s led a lot of companies in the space to big moves higher since the end of March. I’ve been spending a lot of time over the last month paying attention to stocks in this sector, and today I want to add Johnson & Johnson (JNJ).
Johnson & Johnson is categorized as a large-cap pharmaceutical company, and the scope of the brand portfolio means that the odds you use one or more of their products on a regular is very high indeed. Whether you’re thinking about skin lotion, bath soap, adhesive bandages, aspirin or heartburn tablets, it’s a fair bet that you’ll find something made by this company on a shelf in your home. Like most pharmaceutical companies, JNJ is actively working to develop a vaccine in short order; phase one of their vaccine is expected to begin later this year. From a low at around $109 in March 23, the stock is up a little more than 31%, and is only a little off of the highs it reached in early February around $155. Is is still a buy, or is the stock too expensive right now? Let’s find out.
Fundamental and Value Profile
Johnson & Johnson is a holding company, which is engaged in the research and development, manufacture and sale of a range of products in the healthcare field. It operates through three segments: Consumer, Pharmaceutical and Medical Devices. Its primary focus is products related to human health and well-being. The Consumer segment includes a range of products used in the baby care, oral care, skin care, over-the-counter pharmaceutical, women’s health and wound care markets. The Pharmaceutical segment is focused on five therapeutic areas, including immunology, infectious diseases, neuroscience, oncology, and cardiovascular and metabolic diseases. The Medical Devices segment includes a range of products used in the orthopedic, surgery, cardiovascular, diabetes care and vision care fields. Its research facilities are located in the United States, Belgium, Brazil, Canada, China, France, Germany, India, Israel, Japan, the Netherlands, Singapore, Switzerland and the United Kingdom. JNJ’s current market cap is $373.7 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined -4.5%, while sales were 1.7% higher. In the last quarter, earnings dropped -11.3% while sales were flat, but positive by a mere 0.09%. Countering that unremarkable earnings pattern is the reality that JNJ is a company with a very healthy, even strengthening margin profile. In the last quarter, Net Income as a percentage of Revenues was 19.3% versus 18.4% in the last twelve months.
Free Cash Flow: JNJ’s free cash flow is strong, at $23.1 billion. This is also a number that has increased steadily since the fourth quarter of 2016, and translates to a free cash flow yield of 6.13%.
Debt to Equity: JNJ has a debt/equity ratio of .45. This is a conservative number at first blush that generally suggests the company follows a conservative approach to leverage and debt management. Their balance sheet shows cash and liquid assets of $19.3 billion against long-term debt of $26.5 billion. Their operating profile indicates that JNJ should have no problem servicing their debt, with good liquidity as well.
Dividend: JNJ pays an annual dividend of $3.80 per share, which translates to a yield of about 2.65% at the stock’s current price.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $130 per share. That means the stock is a bit overvalued, with -9% downside from its current price.
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: This chart displays the stock’s price activity over the last year. After hitting a 52-week high at nearly $155 in early February, the stock began a rapid decline of -29% before finding a bottom in the last week of March at around $109 per share. The stock’s rebound from that point has been a reflection of the market’s volatility for the last month, and I think also of the institutional rush into the largest and healthiest names in the Healthcare sector. JNJ is currently nearing resistance from previous pivot lows at around $144; a push above that level could give the stock room to rally to $151, or possibly even to retest its 52-week high around $155. Current support is around $137; if the stock breaks below that point, it could fall into the $126 to $130 easily.
Near-term Keys: It might be tempting, given the size and pace of the stock’s rally since March 26, to chase JNJ, and the fundamentals in this case are very strong. If you’re thinking about using JNJ as a smart coronavirus play, though, I’m not sure it fits the bill; there are other companies who are developing vaccines that are anticipated to begin phase 1 trials within the next few weeks, which means that JNJ could fall behind the curve. I also don’t think, fundamental strength notwithstanding, that JNJ offers any kind of useful value proposition. That means the best opportunities to work with this stock really lie with short-term trading strategies. If the stock can keep pushing higher, and move above $144, you could take that as a strong signal to buy the stock or call options, with $151 as a useful bullish profit target. If momentum reverses, and JNJ falls below $137, you might consider shorting the stock or buying put options, with an eye on $130 as a good exit point on a bearish trade.
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