10 Core Stocks for Your Portfolio: Johnson & Johnson

This week and last, we're presenting 10 core stock ideas -- stocks our writers believe can serve as the foundation for a long-term-focused portfolio.

You probably know Johnson & Johnson because of products like Tylenol, Band-Aids, and Johnson's Baby Shampoo.

But if you think those brands are why I'm choosing Johnson & Johnson as one of our 10 core stocks, you're only 15% correct.

That's how much consumer brands like the three above contribute to Johnson & Johnson's profits.

Before I explain further, take a quick look at J&J by the numbers:

Company

Johnson & Johnson (NYSE: JNJ  )

What it does

J&J is a major player all over the health-care space, from consumer products to prescription drugs to medical devices.

Recent Price

$61.97

Market Cap

$170.6 billion

Trailing P/E Ratio

12.8

Return on Equity, Last 12 Months

27.3%

Source: Capital IQ, a division of Standard & Poor's.

The business
It's popular to call Johnson & Johnson a health-care mutual fund. This is a fair characterization. It has over 250 business units located in 60 countries throughout the world. These 250-plus business units contribute to three main lines of business. Here's a summary:

Line

% of Sales

% of Profits*

Key Brands

Consumer

26%

15%

Tylenol, Band-Aid, Johnson's Baby, Stayfree, Neutrogena, Sudafed

Pharmaceuticals

36%

39%

Remicade (inflammatory disorders), Procrit (red blood cell booster), Levaquin (anti-infective), Risperdal Consta (schizophrenia)

Medical Devices

38%

46%

Cordis (heart), DePuy (joint reconstruction, spine), Ethicon (surgical care)

Source: Capital IQ, a division of Standard and Poor's. *Segment information uses operating profits before taxes.

A couple things to note. 1) I could have kept going ... and going ... on the brands. J&J is rife with them. 2) Notice that medical devices and pharmaceuticals drive much more profits (and higher margins) than the more famous consumer brands.

This is important because that means Johnson & Johnson has to keep up its research and development pipelines and/or acquire replacement businesses to replenish patent expiries and keep growth going. This is in contrast to purer consumer goods plays like Kimberly Clark (NYSE: KMB  ) or Procter & Gamble that rely on maintaining their time-tested brands.

In the last 12 months, J&J has continued its long-standing practice of making acquisitions and spent $7 billion on R&D -- that's over 10% of sales. As a percentage of sales, this is less than pharmas Merck (NYSE: MRK  ) and Eli Lilly (NYSE: LLY  ) but more than medical device-makers Stryker (NYSE: SYK  ) and Becton Dickinson (NYSE: BDX  ) .

Why it's a core stock
There are only a handful of companies left that have the top AAA rating on their debt. Johnson & Johnson is one of them. That's a nod both to its conservative capital structure (it had more cash than debt as of its last quarterly filings) and to its ability to generate cash flows to cover its obligations (it converts over 20% of its sales into free cash flow).

J&J's stable of recognized brands and patents form a strong moat to protect its business. To give you an idea of how strong its business is, Johnson & Johnson ranks No. 1 or No. 2 for 70% of its products. And its practice of decentralizing its operations ensures that the behemoth can stay nimble and entrepreneurial to refill the moat.  

Risks
Near-term, Johnson & Johnson has had trouble with numerous recalls on its products. If handled improperly, this kind of bad press can seriously hurt its brands. In addition, there is related litigation risk.

Longer-term, as I talked about earlier, J&J must be efficient in replenishing its drug and medical device pipelines as patents expire.

In sum
Johnson & Johnson is a robust global health care play that is trading for around 11 times trailing free cash flow and is throwing off a 3.5% dividend yield. At current prices, I believe Johnson & Johnson is a solid addition to your portfolio's core. And I'm not the only one. It's recently been picked in our 50 Stocks in 50 Days series, Warren Buffett's Berkshire Hathaway (NYSE: BRK-B  ) has been loading up on the shares, and our CAPS community gives it the maximum 5 stars.

Interested in reading more about Johnson & Johnson? Add it to My Watchlist, which will find all of our Foolish analysis on this stock.

Anand Chokkavelu owns shares of Berkshire Hathaway. Becton Dickinson , Berkshire Hathaway, and Stryker are Motley Fool Inside Value recommendations. Berkshire Hathaway is a Motley Fool Stock Advisor pick. Johnson & Johnson, Kimberly Clark, and Procter & Gamble are Motley Fool Income Investor selections. The Fool owns shares of and has written covered calls on Procter & Gamble. Motley Fool Options has recommended a diagonal call position on Johnson & Johnson. The Fool owns shares of Berkshire Hathaway and Johnson & Johnson.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 26, 2010, at 10:15 AM, admimtopdog wrote:

    As the over all world population starts to age Johnson & Johnson seems to be taking a position to capitalize. With the medical device makers DePuy, Cordis and Ethicon expanding in the U.S. this will mean more jobs in the medical device field. To find out more about upcoming news and more information on high paying medical device sales jobs visit http://www.TopDogMedicalSales.com

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