Dividend Report Card: Johnson & Johnson

In this series, we analyze financial metrics to begin answering the following questions about a company's dividend:

1. Over time, has this company steadily increased its payouts?
2. How sustainable is the dividend?
3. Does the company have room to further increase the dividend?

The Dividend Report Card wasn't designed as a buy or sell signal, but rather as a tool to gauge the health of a company's dividend. For a full explanation of each category, click here for a tutorial.

Today's pupil is Johnson & Johnson (NYSE: JNJ), which posts a 3.6% yield. When we last looked at the company in early March, it scored an A, so let's see if it can retain that top score.

Dividend history

Source: Johnson & Johnson investor relations.

Johnson & Johnson has an enviable dividend track record, having increased its dividend for 49 consecutive years. It should be noted, however, that its dividend growth rate has begun to slow. In 2006, for instance, its trailing five-year dividend growth rate was 15.8%, versus 9.9% today.

Though its 9.9% growth rate is a tiny bit below the 10% threshold for a perfect score in this category, given its distinguished track record, I have no problem rounding up. In this category, then, JNJ scores a 5 out of 5.

Sustainability

Source: Capital IQ (a division of Standard & Poor's) as of Aug. 23.

Johnson & Johnson has a very solid balance sheet, covering each dollar in interest payments with $33 in operating profits. Standard & Poor's gives Johnson & Johnson a perfect AAA credit rating (better than the U.S. government's, apparently).

Since the last time we looked at Johnson & Johnson, its payout ratios have increased slightly and crossed the thresholds into a lower score for those categories. This is primarily due to lower profits stemming from non-recurring legal costs and recall expenses. Still, it's something to keep an eye on going forward.

Despite these non-recurring costs, JNJ still generates plenty of free cash flow and profits to cover for the dividend, so the current payout seems more than sustainable.

Growth

The aforementioned charges over the past year have also lowered Johnson & Johnson's growth scores. Again, it's not much to worry about as long as the depressed profitability is only temporary, but we'll check back in six months to see if these figures have improved.

The median analyst estimate for long-term growth is currently 6.5%, and I would expect annual dividend growth to roughly approximate that figure (between 6% and 8%) over the next few years.

Competitors
An ungraded section of the dividend report card is to see how a stock's current yield stacks up against that of direct competitors. If it's too high relative to competitors' yields, the board could be tempted to slow the growth rate, or vice versa, to bring it more in line with the industry average.

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

With its current yield at 3.6%, Johnson & Johnson's dividend yield seems nicely snuggled between the higher yields of pharmaceutical stocks and the lower yields of medical device companies.

Pencils down!
With all the numbers in, here's how Johnson & Johnson's dividend scored:

A full-letter drop in Johnson & Johnson's Dividend Report Card isn't exactly good news, but it's not reason for panic, either. Given the product recalls and (possibly temporary) reputation loss, the past twelve months just may have been the company's annus horribilis, in which case a B may be considered triumphant. Nevertheless, investors would do well to keep an eye on this historically strong company to see if recent weakness develops into a longer-term trend.

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