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Digging Deeper into JNJ
Board: Johnson & Johnson

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By TwinDeltaTandem
June 11, 2007

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I think to understand JNJ you need to dig back quite a bit farther. JNJ valuations started to get out of control after recovering from its irrational cheapness during '93 and '94. That started a run towards irrational exuberance that was briefly checked (but only partially) in 2000, then shot right through till peaking in '02. Although the price has slightly exceeded the highs of '02 during the rallies of '05 and late '06, these two rallies didn't come close to the max P/Es reached during '02 (P/E actually maxed out above 40 during 1999, but reached into the high 30's in '02).

Like other great companies (cf WMT, MMM), the price didn't crash once the street began to heed Greenspan's warnings. Rather, it's been zeroing in on a more reasonable valuation. You can see this over the past 7 years or so, as the troughs are getting higher and the peaks are, relative to earnings, getting lower.

Throughout this period, and well prior, earnings and dividends have both consistently grown. "Consistently" as in "Cows consistently eat grass."

Therefore, we see that over the past 5 years earnings and dividends have grown at 14.6% and 15.8% compounded; yet price has only improved at a 3.5% annualized growth rate. Assuming earnings continue to grow as they have for the past several decades (EPS has grown 14.0% over the past 35 years), this simply can't continue forever. There are only two relevant questions, in my mind.

First, is there any reason to believe that JNJ's ability to grow EPS at such a very precise yearly rate has all of a sudden vanished? I don't think so. I think the street is sour to JNJ because they pumped it up too high during the bubble. The company has 14 new drugs in late stage development; but more than that, they're extremely well diversified.

Second, if not, when will the stock get so cheap that we just gotta have some?

My charts go back 35 years with P/E, price and dividends. Over that period, the price has only appreciated 9.6%. However, that number is seriously skewed downward by the fact that in 1972 JNJ was trading at an outrageous multiple just like it was in the early 2000's. If we ignore the 70's bubble, JNJ has returned 15% plus dividends forever. Historically, a reasonable high price for the stock today would be around $90/share. I think M*'s sell target of $105 is entirely conservative as a 3-year expectation; and $80 is within reach within even the next 12 months.

It's possible we'll see JNJ trading for less than its current 17.7 P/E. After all, it was cheaper than this in 1984 and 1994. But not for very long. If you'd have bought at the current valuation in 1883, you'd have had a double in 3 years. A purchase at the 18 P/E in Dec '92 would also have doubled in 3 years. So not hitting the very bottom would still have resulted in very sweet returns.

There are people I pay very close attention to who are far smarter than I who see JNJ as a defensive stock. Fine. But what I think makes JNJ really attractive is that constructing a very bullish scenario for this very safe investment is extremely easy and compelling. In short, I think it might be the very best of both worlds.

John


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