There's big news in the Rule Maker Portfolio today. We're taking a page from the Drip Portfolio handbook and placing this month's $500 investment in a new Rule Maker, pharmaceutical and consumer products giant Johnson & Johnson (NYSE: JNJ), the company that makes baby powder, Band-Aids, Tylenol, and a fast-growing stable of prescription drug products.

Before diving into the specifics of this investment, let me give you our thesis on the purchase: We love the pharmaceutical sector. The demographics -- an aging population -- are right. The competitive advantages are right, first, because it's difficult and costly to develop pharmaceutical products, and second, because Johnson & Johnson's broad distribution and manufacturing system gives the company a leg up on many competitors. (It has 190 operating companies in 51 countries.) Margins in the drug business are high. (Johnson & Johnson has 70% gross margins.) And trends in the industry favor the growing importance of drugs and biotechnology products because it's cheaper for insurance companies to pay for a cholesterol-lowering drug today than a heart bypass operation and hospital stay in two years.

It's pretty simple. In the Rule Maker Port, we're looking for shares of companies in a position to double over the next five years and excel for the next 30. We think Johnson & Johnson has the right tools in the tool shed to make this happen.

There are two things we like about Johnson & Johnson: Its past and its future. Founded in 1886, Johnson & Johnson was one of the company's featured in Built to Last, a book that praised the innovative, enduring nature of the world's most visionary companies. Here's a quick look at J&J's vital statistics:

  • It has increased sales every year for the last 68 years
  • It has increased its dividend every year for the last 38 years
  • It has averaged 10.6% annual sales growth for the last 100 years
  • Over the last 100 years, net income has grown 10.5% annually on average
  • Its profitability has actually increased over the last 10 years, due to its growing pharmaceutical business. Net income for the last 10 years grew 15.3% annually
  • Return on equity last year stood at 27%
  • Cash from operations nearly doubled over the last five years
  • Its Cash King Margin jumped to 17% in 2000 from 14.4% in 1998

That's the past. What do we like about J&J's future? First, over the last 20 years the company has transformed itself from a consumer products and lower-end medical products (e.g., sponges, sutures, etc.) company to a provider of higher-end medical products (e.g., stents to prevent the blockage of blood flow to the heart) and pharmaceuticals. The following chart illustrates J&J's three major business segments as a percentage of sales over the last 20 years.

Sales by segment   2000     1990     1980
Consumer            24%      38%      44%
Med. & diag.        35%      33%      32%
Pharma.             41%      29%      18%
Industrial           0%       0%       6%

As you can see, pharmaceutical products -- the fastest growing and most profitable division at Johnson & Johnson -- now generate the bulk of the company's sales. They also account for better than 60% of its operating profits. This is a high-margin revenue stream that's recession-resistant.