Rising Star Buy: Johnson & Johnson

This article is part of our Rising Star portfolios series.

Why am I buying a boring large-cap stock?

Because that's what the market is giving me.

While small-cap stocks have been killing it, large caps have been stagnating. As my colleague Matt Koppenheffer has pointed out, a decade ago it was large caps that were getting huge earnings multiples from the market. Now it's the small caps.

Meanwhile, many of the stocks of the biggest, most dominating companies are trading close to P/E ratios of 10.

That's why I've been buying up stocks in big banking, big defense, and moderately big retail. Make room for big health care!

Now it's time for Johnson & Johnson
Back in October, I wrote an article breaking down exactly how Johnson & Johnson (NYSE: JNJ  ) makes money. At the end of the article, I said "If it slips under $60 a share again, it makes for a very compelling opportunity."

Well, J&J's closing price yesterday was $58.72.

That puts it at 11.5 times next year's earnings with strong cash flows and $10 billion more cash than debt on its balance sheet.

So it's cheap. But more importantly, it's a great company selling for cheap.

Why's it so great?
J&J is a dominant force in consumer products, pharmaceuticals, and medical devices. Basically, J&J has you covered from your bathroom cabinet to the operating table. The secret to its ability to offer so many health-care products so effectively is its decentralization. It allows for entrepreneurial activity under the umbrella (and financing costs) of a AAA-rated balance sheet. That's a powerful combination when done correctly.

This is the same advantage Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) brings to bear. Warren Buffett allows his managers to do their thing and he worries about allocating capital from up top. Perhaps that's why Berkshire owns 45 million shares of J&J.

It's also important to remember that despite its many businesses and acquisitions, J&J sticks with health-care-related products. It's a conglomerate, but it's a laser-focused conglomerate.

The main risks
Perhaps decentralization contributed to the spate of recalls of J&J products. Perhaps not. But the sheer quantity of recalls we've seen from Johnson & Johnson is scary and has the potential to unravel my investment thesis. Any brand fallout from these recalls is the key risk to watch.

In addition, as with any company that relies heavily on patents, J&J's patent expirations and pipeline of products should be monitored. Fortunately, its largest product, Remicade, which treats inflammatory disorders like rheumatoid arthritis, accounts for only 7% of sales. For comparison, Lipitor made up 16% of Pfizer's (NYSE: PFE  ) sales last year and Singulair made up 11% of Merck's (NYSE: MRK  ) sales.

The takeaway
Bottom line, Johnson & Johnson is a great company selling for a good price. In a strong bull market, it'll likely lag (as it has been doing), but its consistency and 3.7% dividend yield should help it outperform in a bear market and overall.

Tomorrow, I'm buying shares of Johnson & Johnson in the real-money portfolio I manage for The Motley Fool. If you're likewise intrigued, consider buying shares yourself and consider following along with our analysis by adding J&J to The Motley Fool's watchlist tool.

Anand Chokkavelu owns shares of Berkshire Hathaway and Pfizer. Berkshire Hathaway, Johnson & Johnson, and Pfizer are Motley Fool Inside Value recommendations. Berkshire Hathaway is a Motley Fool Stock Advisor recommendation. Johnson & Johnson is a Motley Fool Income Investor choice. Motley Fool Options has recommended a diagonal call position on Johnson & Johnson. The Fool owns shares of Berkshire Hathaway, and Johnson & Johnson. Motley Fool Alpha LLC owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. 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 Motley Fool has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (17)

Comments from our Foolish Readers

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 March 24, 2011, at 4:04 PM, landoncz wrote:

    Where there's smoke, there's fire. The sheer number of JNJ recalls should cause one to question whether they might have something systematically wrong with their production. If so, it is only a matter of time before a truly costly recall, a lawsuit, or a capital expenditure will ruin your investment thesis...

    But, these recalls could all just be a coincidence...

  • Report this Comment On March 24, 2011, at 8:28 PM, knighttof3 wrote:

    You discuss why it's so great. Now tell us why you think it's so cheap. I'd like to add at this price, but is it the usual irrational depression from Mr Market; or, as one of the most analyzed companies, Mr Market sees something you missed such as recalls or Mr Weldon's awful leadership?

  • Report this Comment On March 25, 2011, at 11:06 AM, TMFBomb wrote:

    @landoncz and knighttof3,

    I am certainly concerned about the recalls...the sheer number does smell smoky as landoncz pointed out...as I stated in the article, the recalls have the potential to unravel my investing thesis. I'm making the call that the risk is worth the reward on J&J, but I could very easily be proven wrong.

    Fool on!

    -Anand

  • Report this Comment On March 28, 2011, at 8:45 PM, PeyDaFool wrote:

    Hope not... it's my largest holding.

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