Drip Portfolio Report
Wednesday, October 8, 1997
by Randy Befumo (TMF Templr@aol.com)

ALEXANDRIA, VA (Oct. 8, 1997) -- Besides Pfizer, the other healthcare company Jeff favors is medical products giant JOHNSON & JOHNSON (NYSE: JNJ). Jeff is partial to ol' J&J and I must admit that after a review of the valuation and the inherent quality of the business, I think the current price is very attractive. Today, I will outline my reasoning and try to again explain why buying a company that is fairly valued in today's dollars with a twenty-year time horizon is a great opportunity, but buying a company that is overvalued in today's dollars for a twenty-year time period will more than likely result in mediocre investment returns.

Jeff gave an overview of Johnson & Johnson on September 29th and September 30th, so I will not bore you by repeating this. I think all three of the companies' businesses (the manufacture and sale of medical products and instrumentation, pharmaceuticals, and consumer health-related products) are attractive. They offer above-average operating margins, consistent above-average revenue growth, and businesses where a brand name like Johnson & Johnson helps to spur sales and reduce marketing and distribution costs. They also offer them all in one neat package that you can put $50 to $100 a month in for the next twenty years.

Johnson & Johnson as a business is absurdly profitable. The company's net profit margin over the last twelve months has been 14.0% according to Marketguide, in line with the medical industry products as a whole. Given that it has achieved the margins with 29.3% of its revenues coming from the competitive consumer products area, this is particularly impressive. Although Pfizer's net profit margin is 17.6%, the company did this by focusing on higher-margin sales in ethical drugs.

While high-margin sales are nice, you have to ensure that the overall rate of sales growth is solid as well. Johnson & Johnson in my opinion marries these two needs, offering slightly higher sales growth that compensates to a large degree for the lower net profit margins. No other major medical products or pharmaceutical company short of WARNER-LAMBERT (NYSE: WLA) has the same kind of exposure to a fast-growing consumer market. As Johnson & Johnson has been gradually notching up its net profit margins, the higher rate of sales growth means that the concomitant earnings growth will be magnified.

Perhaps Johnson & Johnson's greatest asset currently is one that is not carried on the books -- the company's brand name. The company has been able to penetrate new markets in both medical products and drugs with less marketing spending than another competitor might have had to do because its brand is so widely recognized by both professionals and consumers. The real value of a brand is not that everyone recognizes -- that is incidental. It is that the company does not have to spend as much as it otherwise would when marketing its products and when entering into new product categories. A Johnson & Johnson line of wheelchairs and other ambulatory care products would not require a lot of advertising to put the name in the heads of customers. They would just have to produce a high-quality product and it would garner support.

Another company and industry I have looked at outside the context of the Drip Portfolio is COLUMBIA/HCA (NYSE: COL) and other healthcare providers. This is one business that Johnson & Johnson is not involved in. Although the company does not participate in the delivery of care like Columbia/HCA, J&J enables this care and its distribution channels have benefited from all of the major trends in healthcare, particularly managed care. Frankly, given that the delivery of care at hospitals or through HMOs carries lower margins and requires more in the way of assets, this business is not as attractive as the portfolio of businesses Johnson & Johnson offers and should carry a slightly lower valuation to reflect this.

Anyway, Johnson & Johnson is the GENERAL ELECTRIC (NYSE: GE) of the medical world, exerting dominance in all of its major markets. In many ways, the company is like a well-managed healthcare mutual fund that completely owns all of its major businesses. It current trades at an 8% premium to the S&P 500's average P/E with a 1.4% dividend yield and a projected 14.1% long-term growth rate. GE, for its part, sells at a 25% premium to the market, has a 1.5% yield, and is only forecast to grow at 13.0% a year. For all those who have written Jeff and me e-mails pounding the table on GE, I would say, look at Johnson & Johnson. The company carries a higher growth rate, a lower valuation, and an equivalent dividend yield. The return to shareholders has to be higher.

Although Pfizer is forecast to grow earnings 4% per year faster than Johnson & Johnson beginning next year, the starting valuation for J&J is one-third lower. Should J&J grow at 14.1% over the next twenty years, it will have $32.73 in earnings per share. Should Pfizer grow earnings at 18% a year for five years after this next year and then revert back to 15%, you would have $26.62 in earnings per share. Pfizer would have to maintain a valuation more than 40% higher than J&J to justify the difference. Even with the long time period, starting from a lower valuation point makes a world of difference. As of this evening, Jeff and I will start to put together the paperwork to send off to the Temper of the Times to purchase our first share of Johnson & Johnson.


                    Day   Month Year  History
        Drip:    +0.00%   0.00%  0.00% 0.00%
        S&P:     +0.00%   0.00%  0.00% 0.00%
        NASDAQ:  +0.00%   0.00%  0.00% 0.00%

        Rec'd   #    Security         In At      
       9/8/97   1      Intel         $94.69      

                        Base: $700.00
                    Expenses: $ 55.50 (Moneypaper)
                   Purchases: See above
                        Cash: $549.10
                 Total Value: $652.00 apprx.

The portfolio began with $500 on July 28, 1997, adds $100 on the 15th of every month, and the goal is to have $150,000 by August of the year 2017.