It's that time of the year again when Johnson & Johnson's (JNJ -1.21%) shareholders eagerly await their annual "raise" in the form of a higher dividend payout. On Thursday, April 27, J&J obliged once more.

It really shouldn't come as any surprise that Johnson & Johnson chose to increase its dividend payout by 5%, or $0.04 per share, to $0.84 a quarter. After all, Johnson & Johnson is among the most elite of Dividend Aristocrats (companies that have raised their annual dividends for at least 25 consecutive years). With this increase, J&J lifted its annual dividend for the 55th straight year. You can count on just two hands the publicly traded companies have increased their payout for longer than 55 straight years.

Based on the new aggregate annual payout of $3.36 per share, J&J's dividend yield will move higher to 2.7% from 2.6%. More importantly, its yield remains consistently head and shoulders above the average yield of the broad-based S&P 500. Combined with its exceptionally low volatility, J&J's superior income potential is what makes it a staple holding for pre- and post-retirees.

An investor counting up a stack of dividend income.

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Could J&J's dividend increase offers clues about its future?

However, J&J's recently announced dividend increase may also offer a pretty big clue as to what the future might hold for the company.

If you recall, back in late March I took an educated guess as to how much J&J would raise its quarterly dividend this year. My guess was $0.85, so I was $0.01 too optimistic. But it's the comparison of this year's increase to increases in previous years that has me intrigued.

Here's an eight-year rundown of J&J's dividend increases on a percentage basis:

  • 2010: 10.2%
  • 2011: 5.6%
  • 2012: 7%
  • 2013: 8.1%
  • 2014: 6.1%
  • 2015: 7.1%
  • 2016: 6.7%
  • 2017: 5% 

You'll note that this this year's increase of 5% is actually a low mark over the past eight years. It's possible the rule of large numbers is catching up a bit with J&J, as its payout has grown from $0.49 to $0.84 per quarter over the above years. But I wouldn't buy this thesis. Instead, I believe there's something else at play that caused J&J to moderate its dividend hike in 2017.

A businessman holding a for sale sign.

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It's simple: J&J wants to keep shopping

Johnson & Johnson recently announced its intent to acquire Swiss-based lung drug specialist Actelion (NASDAQOTH: ALIOF) for $30 billion. The deal, which gives J&J sole possession of Actelion's pulmonary arterial hypertension portfolio and a 16% stake in an expected spinoff company that'll contain Actelion's developing drug candidates, is expected to boost J&J's long-term growth rate by 1.5% to 2% annually. When combined with share buybacks, Wall Street has J&J pegged for 5% to 7% annual EPS growth through 2020.

In other words, there should be sufficient EPS growth to justify dividend hikes of 6% to 7% per year. Yet J&J, which has long kept its payout ratio right around or above 50%, could be sporting a payout ratio of between 44% and 47% based on Wall Street's full-year EPS consensus for 2018 and 2017, respectively, which is a bit low.

My suspicion is that J&J is still adamant about using acquisitions to bolster its bottom-line, and it wants to use as much of its free cash flow as possible to make that happen.

If we look at J&J's first-quarter report, we can see pretty clear evidence that it's going to need some sort of inorganic growth to help offset weaker sales in key pharmaceutical products. Remicade's sales fell by a low single-digit percentage as biosimilar competition hits pharmacy shelves, while blockbuster SGLT2 inhibitor Invokana, used to treat type 2 diabetes, saw sales plunge 17% year-over-year in the United States. After regularly delivering high-single-digit pharma sales growth, J&J's domestic pharma sales declined 0.4% in Q1 2017. That's unacceptable, and it demands an immediate fix.

Acquisitions give J&J the pathway to that quick fix, and more modest dividend increases would give J&J even more cash flow to work with.

Two businessmen shaking hands, signaling a merger, deal, or buyout.

Image source: Getty Images.

The most logical acquisition

Historically, large acquisitions aren't J&J's bread-and-butter. It much often prefers to acquire small- and mid-sized companies that it can mold to fit its more than 250-subsidiary puzzle. While deciding which company might be on J&J's radar is nothing more than a dart throw at best, the most logical acquisition could be current developmental partner Geron (GERN -0.11%).

In Nov. 2014, J&J handed over $35 million in upfront cash to Geron and dangled a $900 million milestone bounty for development-, regulatory-, and sales-based milestones associated with imetelstat. This is a drug targeted at myelofibrosis and myelodysplastic syndromes. 

In early stage studies, imetelstat generated partial and complete responses in myelofibrosis patients, which is something that had never before been seen in a clinical trial. In fact, the only approved therapy for myelofibrosis patients (a drug called Jakafi) treats some of the symptoms associated with the disease, such as an enlarged spleen, but does nothing to thwart the progression of the disease. In short, imetelstat could become the clear go-to myelofibrosis drug if approved, and thusly have blockbuster potential. A positive late-stage study could coerce J&J to acquire Geron and save itself the trouble of paying milestones and royalties.

Long story short, don't be surprised if J&J's intermediate-term dividend hikes are a bit disappointing as it focuses on reigniting domestic pharma growth through acquisitions.