I like investing in individual stocks. I like studying a Company’s “story”. I like analyzing its financials. And I love becoming a part owner in a business.
Investing in individuals stocks isn’t for everyone though. Homework is required. Owning individual stocks can result in volatility so you have to be able to stomach price swings. This isn’t for everyone. If individual stocks aren’t your thing, focus on ETFs.
As I’ve noted before, I think the S&P 500 as a whole is overvalued with a Shiller P/E ratio of 28.5 and a current P/E ratio of 25.8. Link these. Both of these figures are rich based on historic valuations. So is there anything worth investing in right now?
As it happens, I think one of the best stocks in the world is a relative bargain right now:
Johnson & Johnson
The healthcare behemoth that we are all familiar with. Most of us have heard of the brands: Tylenol, Neutrogena, Aveeno, Listerine, and Band-Aid – they’re all under the Johnson & Johnson umbrella.
But most people don’t realize that Johnson & Johnson actually earns most of its revenue from two other segments: pharmaceuticals and medical devices. These are the higher growth areas, particularly pharmaceuticals.
In addition, the Company earns nearly 50% of its revenue from outside of the US. So by effectively investing in Johnson & Johnson, you get access to the international health care market.
Healthcare has been one of the most profitable industries to invest in over the last 30-50 years. Providing results that beat the market. An investment in a 100 shares of Johnson & Johnson 20 years ago would yield $34,590 today while the same investment in the S&P 500 would yield only $23,206 (both with dividends reinvested).
How is the repeal of Obamacare going to impact Johnson & Johnson? Uncertain. But the Trump administration wants to curtail Regulation and reduce corporate taxes. These two things should add to the Company’s bottom line – potentially resulting in higher dividends, more share buybacks and possible price appreciation.
Johnson & Johnson released its full-year 2016 earnings yesterday and the stock fell on the news as sales missed expectations. I think the drop in price was short-sighted though as Earnings Per Share (“EPS”) rose by 8% year-over-year. Based on 2016 earnings, the stock currently trades at a P/E ratio of 19. The forward P/E ratio is around 17 (based on 2017 expected earnings). So Johnson & Johnson is trading at a cheaper valuation than the S&P 500 as a whole – as noted above the S&P 500 is trading at a P/E ratio of nearly 26.
The Company has a fortress-like balance sheet with $40B of cash, enough to pay off all debt and have plenty left over. It is only one of two companies in the world with an AAA credit rating (the other is Microsoft).
The Company has tremendous earnings power as its profit margins and return on equity exceed 20% on average over the last 10 years. Sustaining this over such a long period is difficult, especially considering that this includes the Great Recession period.
Johnson & Johnson has increased its dividend each year for over 50 consecutive years – making it a dividend king. Currently, the dividend only takes up about half of its earnings so the Company can increase its dividend further or its earnings could fall in half and the dividend would be okay.
So what do I expect going forward?
The starting dividend yield is 2.85%. Share buybacks may add 1% to returns. And the Company should be able to grow earnings by 5-7% over the long-haul. So I would expect returns of 9-11% from Johnson & Johnson over the long-term. I would expect the stock to beat the market by a point or two over the long-term since it is currently trading at a discount to the S&P 500. Using a 10% rate of return, a $10,000 investment in Johnson & Johnson today may result in an investment value of $67,275 in 20 years (assuming the shares are held in a tax-deferred account).
Johnson & Johnson is currently one of my biggest holdings and I plan to add more as soon as my cash reserves get to the levels that I want them.
I like to put my Johnson & Johnson shares in my tax-deferred accounts (RRSP) to avoid having to pay tax on the dividends. If you’re American, you can probably put the shares in an IRA, ROTH IRA, or 401(K) to get a tax-deferral.