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More often than not, dividend stocks are the foundation on which great retirement portfolios are built. Among dividend-paying stocks, few are more revered than healthcare conglomerate Johnson & Johnson (JNJ 0.67%).
Johnson & Johnson is among an elite class of dividend-paying stocks known as Dividend Aristocrats. To join this club, a company needs to have raised its annual dividend in a minimum of 25 straight years. Currently, there are just four dozen members of this elite club, and you can count on two hands the number of publicly listed companies that have a longer streak of raising their dividend than Johnson & Johnson, which is riding a 53-year streak. For added context, there are more than 7,000 publicly traded stocks.
But the big question on the minds of income investors as we head into 2016 is whether Johnson & Johnson can make it a 54th consecutive year. My suspicion is that it indeed will.
A reasonable payout ratio
To begin with, Johnson & Johnson has a reasonably low payout ratio despite raising its dividend for more than five straight decades. Even following a 7% boost in 2015 to $0.75 per quarter, the $3 annual payout still works out to a payout ratio of only 49% based on the midpoint of the $6.15 to $6.20 in full-year EPS that Johnson & Johnson forecasted during its third-quarter conference call.
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Ideally, we like to see companies returning anywhere from 50% to 75% of their profit to shareholders in the form of a dividend as it demonstrates a willingness to boost shareholder value and it gives ample room for ongoing increases. With a dividend raise in 2016, Johnson & Johnson would probably approach a 50% payout ratio.
Substantial cash flow
Secondly, Johnson & Johnson has more than enough cash flow (and cash on hand) to consider paying more to its shareholders. Johnson & Johnson ended the third quarter with $17 billion in net cash, although the company's management team has stated that it's actively searching for attractive acquisition opportunities with those funds. Aside from its cash balance, J&J has generated nearly $15 billion in free cash flow over the trailing-12-month period, and has produced no less than $11.4 billion in free cash flow in any year since 2005. In sum, it has more than enough positive cash flow to hand over to investors.
A three-pronged business primed for growth
Another key point is that Johnson & Johnson has the long-term growth outlook to support a rising dividend payment. J&J is actually a three-headed growth machine, with each of its business segments playing an important role.
Image source: Johnson & Johnson.
Its consumer health products segments, highlighted by Tylenol, grows slowly, but many of its products are inelastic, meaning consumers buy them regardless of how well or poorly the economy is performing. This means J&J tends to have strong pricing power and predictable cash flow from its consumer health business.
J&J's medical device segment has also been growing slowly recently, largely because of uncertainties surrounding the Affordable Care Act in the U.S. and economic weakness throughout Europe. However, medical devices are a smart play for the future as life expectancies around the globe improve. This segment offers long-tail growth for J&J, and as demand improves, pricing should improve as well.
We also have J&J's bread-and-butter pharmaceutical segment, which is its source of high margins and rapid growth. Like any pharmaceutical company, J&J will be forced to contend with impending patent losses, such as with anti-inflammatory blockbuster Remicade. But J&J has also delivered exceptional growth from the likes of type 2 diabetes drug Invokana. It also has the expectation of filing for 10 new drug approvals that it believes could be blockbusters by 2019.
A collaborative touch
The last piece of the puzzle for J&J, and somewhat an extension of the pharmaceutical segment discussion above, is that it has been outstanding when it comes to forging collaborations. J&J's partnership with a little-known biotech named Pharmacyclics allowed it to co-develop a blood cancer drug, which became known as Imbruvica. Based on estimates from Wall Street, Imbruvica could have the potential to reach in excess of $5 billion in annual sales.
What's up next for Johnson & Johnson? It's always on the lookout for partnership possibilities, and the deal it formed in Nov. 2014 with Geron (GERN 1.36%) could prove its next big winner. Geron, a small-cap drug developer with one drug in its pipeline, imetelstat, caught the attention of J&J after a phase 1 study in myelofibrosis patients (a rare cancer of the bone marrow that leads to scarring) showed that imetelstat led to objective responses in patients. The only approved treatment on pharmacy shelves at the moment for myelofibrosis, Jakafi, is a JAK2 inhibitor, and it merely alleviates the symptoms associated with myelofibrosis without delivering an objective response. If Geron's imetelstat can find traction in myelofibrosis and other cancers, it could also become a very profitable drug.
Given all of these factors working in J&J's favor, it seems probable that Johnson & Johnson will reward shareholders with another dividend increase in the mid- to high-single-digit percentage range in 2016.
