The year 2020 has been full of surprises. Growth stocks, which are usually the first to get battered during economic downturns, have performed exceptionally well, while many stable and mature companies have been poor performers.
Historically, Johnson & Johnson (JNJ +1.12%) has been considered a safe stock with a strong commitment to growing dividends. Berkshire Hathaway (BRK.A +0.20%)(BRK.B 0.03%) CEO Warren Buffett has held on to this healthcare conglomerate for the past 14 years, though he dumped a significant amount of its stock in 2012 in disappointment over the many manufacturing and legal issues it faced. The company has failed to impress in 2020; the stock is up just 1.6% year to date (YTD), which is surprising considering that the S&P 500 is up 9.7% in the same time frame.
Investors are concerned that the ongoing surge in COVID-19 cases across the world may continue to drag on the number of medical procedures being performed -- such procedures are a key demand driver for medical devices. They're also worried about low top-line growth, regulatory hurdles, drug-pricing pressures, and ongoing biosimilar competition for the company's blockbuster immunology drug, Remicade (sales of which were $2.8 billion, or 2.8% of the company's total revenue, in the first nine months of 2020). Meanwhile, Johnson & Johnson remains entangled in myriad lawsuits involving its role in opioid abuse, faulty hip implants, and asbestos contamination in baby powder and talc products. These lawsuits, which involve settlements worth billions of dollars, are a major concern.
Despite these risks, the company remains one of the least volatile and highest-quality stocks in the U.S. market. Here are four reasons why healthcare investors should consider picking up a position in Johnson & Johnson.
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1. Gradually improving business fundamentals
The COVID-19 pandemic had a negative impact on Johnson & Johnson's second-quarter results. Hospitals delayed non-elective procedures, which in turn affected sales in the company's medical devices segment. Demand for consumer products also declined as people who had stocked up on these products in the first quarter avoided visiting stores during the lockdown.
Although Johnson & Johnson has not recovered to pre-pandemic levels, the third-quarter results can be considered a move in the right direction. Global sales are up 1.7% year-over-year (YOY) to $21.1 billion. While that growth rate is nothing too exciting, it is nevertheless a significant improvement from the YOY sales decline of 10.8% reported in the second quarter. The company's global pharmaceutical sales rose 4.6% YOY to $11.4 billion, while global consumer health sales rose 3% YOY to $3.5 billion. Global medical device sales were down 3.9% YOY to $6.2 billion in the third quarter. However, this segment dramatically improved sequentially -- it had dropped 32.7% YOY to $4.3 billion in the second quarter.
A diversified presence across product segments and therapeutic areas, extensive geographic market penetration, and brand power in both the healthcare and consumer sectors have all been helping the company survive the difficult times. Johnson & Johnson has now raised its fiscal 2020 revenue guidance to $81.2 billion to $82 billion, a slight improvement from its previous forecast of $79.9 billion to $81.4 billion.
2. Signs of broad economic recovery
On Nov. 9, Pfizer (PFE +0.47%) and BioNTech (BNTX +0.73%) announced interim results from a late-stage study for their investigational COVID-19 vaccine candidate, BNT162b2. The results showed the vaccine's efficacy to be higher than 90% in patients not previously infected with COVID-19. This development has now led to a marketwide rally in value stocks, with investors beginning to expect the economy to finally recover to pre-pandemic levels.
Johnson & Johnson stands to benefit significantly from this development, as its medical device and consumer health sales may now recover much faster than previously expected. Reflecting these expectations, the stock has already gained more than 7% in the past week.
3. Commitment to research and development
The research and development (R&D) pipeline is the key growth engine for a healthcare company. In the third quarter, Johnson & Johnson spent $2.8 billion on R&D activities, accounting for 13.5% of its total revenue. Despite the pandemic, the company has increased its R&D spending YOY by 9.3%, and it spent a total of $50 billion on R&D from 2015 to 2019.
This commitment has borne fruit for Johnson & Johnson. New products launched since 2015 accounted for 25% of the company's sales in 2019. The high contribution of the new product launches to the company's top line bears testimony to the success of its R&D pipeline.
4. Solid dividend yield
A member of the prestigious S&P Dividend Kings list (comprised of companies that have increased their dividends for at least 50 consecutive years), Johnson & Johnson boasts a current dividend yield of 2.8%. That amounts to $4.04 per share, much higher than the S&P 500's average of 1.8%. The company's cash payout ratio is 60.8%, while its free cash flow (FCF) dividend coverage ratio (calculated by dividing free cash flow per share by dividend per share) is 4.9. Hence, Johnson & Johnson has the financial flexibility required to fulfill its dividend commitments.
Johnson & Johnson is trading at a forward price-to-earnings (P/E) multiple (calculated by dividing share price by forecasted earnings per share for the next fiscal year) of 16.4. Peers Pfizer, Merck (MRK 0.03%), and Bristol Myers Squibb (BMY 1.20%) are trading at forward P/E multiples of 12.1, 12.7, and 8.7, respectively.
It is apparent that investors value Johnson & Johnson for its stable business and long-term commitment to dividend growth, despite the many risks it faces. The company's valuation, although not cheap, seems reasonable considering the dearth of other high-quality, safe assets in today's volatile market environment. Hence, based on its risk-reward proposition, Johnson & Johnson can be a smart buy for healthcare investors with average risk appetite.
