Is Johnson & Johnson the Perfect Stock?

Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?

One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if Johnson & Johnson (NYSE: JNJ  ) fits the bill.

The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.

Some of the most basic yet important things to look for in a stock are:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
  • Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
  • Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
  • Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Johnson & Johnson.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 4.0% Fail
  1-Year Revenue Growth > 12% (0.5%) Fail
Margins Gross Margin > 35% 69.5% Pass
  Net Margin > 15% 21.7% Pass
Balance Sheet Debt to Equity < 50% 21.9% Pass
  Current Ratio > 1.3 2.45 Pass
Opportunities Return on Equity > 15% 24.7% Pass
Valuation Normalized P/E < 20 15.80 Pass
Dividends Current Yield > 2% 3.6% Pass
  5-Year Dividend Growth > 10% 10.9% Pass
       
  Total Score   8 out of 10

Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.

With a score of eight, Johnson & Johnson comes off looking pretty close to perfect. But a series of recent setbacks is threatening the dominance of this health care and consumer products giant.

Johnson & Johnson brings a unique combination of businesses to the table. With pharmaceuticals, medical devices, and consumer-targeted over-the-counter products, the company is both a household favorite as well as a renowned innovator. That combination has also helped boost J&J's numbers, with returns on equity and net margins substantially higher than both big pharma companies Merck (NYSE: MRK  ) and Abbott Labs (NYSE: ABT  ) as well as medical device makers Stryker (NYSE: SYK  ) and Zimmer Holdings (NYSE: ZMH  ) .

But the past year has been terrible for J&J. A huge run of recalls brought a 15% drop in consumer health care revenue in its most recent earnings report, and pharmaceutical sales also dropped substantially. With stagnant performance in its medical device and diagnostics business, J&J finds itself in need of a recovery.

Ordinarily, few would argue that Johnson & Johnson won't come back strongly. But with so many problems, some are questioning whether permanent damage to J&J's reputation has been done. If it has, then what seems like an obvious value play could trap investors who are hypnotized by the company's long history of outperformance.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Click here to add Johnson & Johnson to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Johnson & Johnson and Stryker are Motley Fool Inside Value selections. Motley Fool Options has recommended a diagonal call position on Johnson & Johnson, which is also a Motley Fool Income Investor recommendation. The Fool owns shares of Johnson & Johnson. Motley Fool Alpha owns shares of Abbott Laboratories and Johnson & Johnson. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The 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 January 31, 2011, at 4:01 PM, rmani81 wrote:

    JNJ has the track history of a real champion. Huge inventory of everyday products that will be expanding. I think it's a great buy at this price.

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