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2 Scorching Hot Big Brand Stocks -- Are They Buys?

By Leo Sun - Jul 16, 2016 at 2:11PM

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Johnson & Johnson and General Mills are great “big brand” stocks, but has the recent rally in defensive stocks made them overvalued?

Many "big brand" companies that sell well-known consumer brands hold up well during market downturns due to their defensive nature. Let's examine two big brand companies that have outperformed the market over the past year, and whether or not they are still viable long-term buys at today's prices.

Johnson & Johnson

Despite its reputation as a slow-growth defensive stock, Johnson & Johnson (JNJ -0.09%) has rallied more than 24% over the past 12 months, easily outperforming the S&P 500's 4% gain.

Image source: Company websites.

Mainstream investors are likely well-acquainted with J&J's consumer healthcare business, which sells well-known products like Tylenol, Band-Aids, Listerine mouthwash, and Acuvue contact lenses. However, the consumer healthcare unit is actually J&J's smallest business, accounting for just 18% of its sales last quarter. Its larger pharmaceutical and medical device businesses generated 47% and 35% of its total sales, respectively.

The pharmaceutical unit is J&J's fastest growing business, fueled by robust sales of Imbruvica, an oral therapy for certain blood and lymph node cancers. Xarelto, an oral anticoagulant, the multiple myeloma treatment Darzalex, and the type 2 diabetes treatment Invokana have also been strong sellers. That growth offset single-digit sales declines at its consumer and medical device businesses, which boosted revenue by 0.6% and adjusted earnings by 7.7% annually last quarter. A strong dollar has notably been tough on J&J's top and bottom lines, since only 53% of its sales come from the U.S.

J&J might seem like a fairly "safe" stock to buy, but investors should note that the stock's trailing P/E of 22 hovers at a multi-year high, while its trailing yield of 2.4% is at a multi-year low. That's a pretty hot valuation for a company that is only expected to post 2% sales growth and 7% earnings growth this year. Therefore, value-seeking income investors might want to wait for its multiple to cool off and its yield to rise before buying shares.

General Mills

General Mills (GIS 0.58%) dominates supermarket aisles with brands like Cheerios, Haagen-Dazs, Yoplait, Betty Crocker, and Old El Paso. It's also crushed the S&P 500 with a 26% gain over the past 12 months.

Image source: Pixabay.

Last quarter, General Mills' U.S retail sales fell 12% to $2.2 billion, international sales dipped 1.5% to $1.2 billion, and its convenience and foodservice sales dropped 7.8% to $487 million. Operating income declined for the U.S. and International segments, but rose slightly at its convenience store and foodservice unit. Total sales fell 9% annually to $3.9 billion, and declined 8% on a constant currency basis. However, nine percentage points of that decline was caused by one less week compared to the prior year quarter and the impact of acquisitions and divestitures. Adjusted earnings improved just 2% as reported and 5% on a constant currency basis.

On an organic basis, which excludes the aforementioned impacts, General Mills expects sales to grow 0% to 2% for fiscal 2017. Adjusted earnings are expected to rise 6% to 8% on a constant currency basis, which makes its trailing P/E of 26 (which has hovered at multi-year highs since last year) seem pretty high. Like J&J, General Mills' trailing yield of 2.5% is also at a multi-year low, so investors should probably also wait for this stock to cool off before buying any shares.

Beware the "defensive" rally

J&J and General Mills are great long term investments, but I believe the year-long rally in dividend-paying defensive stocks has been fueled by low interest rates (which attracted yield-seeking investors and enabled companies to use debt-fueled buybacks) and economic turmoil abroad, rather than the actual growth of their core businesses.

This means that interest rate hikes and increased investor appetite for riskier stocks could deal a double whammy to stocks like J&J and General Mills in the near future, which would pull their valuations back to reasonable levels while boosting their yields. When that happens, it would be a more ideal time to buy shares of J&J, General Mills, or other comparable "big brand" stocks.

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Stocks Mentioned

Johnson & Johnson Stock Quote
Johnson & Johnson
$182.12 (-0.09%) $0.17
General Mills, Inc. Stock Quote
General Mills, Inc.
$71.04 (0.58%) $0.41

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