Tuesday, August 09, 2011

Johnson and Johnson: A Regal Dividend Stock That Is Very Cheap

To dividend investors big sell offs like the one we have witnessed over the last couple of weeks provide tremendous buying opportunities. That may sound like a big DUH, but as Warren Buffett says, "When the water goes out it's easy to see who was swimming naked." We believe Mr. Buffett meant that statement in the context of wrong bets related to debt.  We have found, however, that "when the water goes out" in the stock market, it is much easier to see those companies that are not only fully clothed but are regally attired.  Regally attired in the sense of having the rare qualities of unquestioned safety and consistent growth.

There are a handful of companies in the world that can qualify under our most stringent safety and growth standards, unfortunately, these companies are almost always fully priced.  Everyone knows they are outstanding companies and everyone owns them.  The only time we can buy these regal companies at bargain prices is when a big sell off in the market causes people to abandon stocks in general.  When that happens, like over the last few days, the regal stocks get thrown out with the common folk.

Let us discuss one stock that we consider regal, Johnson and Johnson (JNJ).  Here is a brief thought process of why we rate it so highly and why it is the kind of stock we buy every time the "water goes out."

  1. Safety:  JNJ is one of only four companies in the US that is still rated AAA.  Yes you heard that right.  S&P, in cutting the rating of US debt, went to great lengths to explain that JNJ's rating was not dependent on that of the US.  JNJ is AAA on its own merits of financial strength, diversification of business lines, geographic diversification, growth, and sound leadership. JNJ has more cash than debt. 
  2. Growth:  JNJ has grown its earnings by an average annual rate of 7.5% over the last 10 years.  It dividend has grown in the low double-digits%.  With the uncertainties of the new health-care plan, we project that JNJ's dividend growth rate will slow to the 7.5%-8% level over the next 3-5 years. At that rate, JNJ's dividend will double in about 10 years.
  3. Dividends:  JNJ's current dividend yield is 3.7%.  That is nearly 1.3% more than the yield on a 10-year US Treasury bond.  The company has paid a dividend since 1944 and has raised it dividend every year for the last 48 years.
  4. Valuation: Our proprietary Dividend Valuation Model is estimating that JNJ is just over 30% undervalued. 
  5. Timing: We don't try to time the market, but the manner in which stocks have fallen in recent days usually takes time to calm down.  We think JNJ is a good value at current prices, but with a bit of patience one might be able to buy it a bit cheaper over the next few weeks.
We own JNJ and plan to buy more.