Investors can focus on dividend growth stocks for many reasons. Maybe you're a retiree who appreciates increasing payouts on a fixed income, or maybe you're a young investor who's encouraged by the quarterly cash infusions. Whatever the reason, if you're looking for a dividend growth stock, finding one with a great track record is necessary, but not sufficient -- you also want to be sure those payouts will continue to expand.
Healthcare giant Johnson & Johnson (JNJ -1.15%) is a Dividend King, with 59 consecutive annual dividend increases to its name. But how likely is that to continue? Let's take a look at whether Johnson & Johnson's dividend is the safest in the healthcare industry.
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A conservative payout ratio
We'll start by checking the company's payout ratio -- the portion of earnings per share (EPS) that gets paid out as dividends. Specifically, we'll look at non-GAAP EPS. GAAP stands for Generally Accepted Accounting Principles, and while this method of financial reporting provides consistency in comparing results between companies, it can also fail to account for certain items that can affect results.
In Johnson & Johnson's case, some examples would be the amortization of intangible assets (i.e., the gradual decline in book value for Johnson & Johnson's countless patents) and one-time costs for restructuring or litigation.
Regarding the latter, the company is currently facing significant litigation costs. Most recently, the U.S. Supreme Court upheld a lower Missouri court's ruling in forcing Johnson & Johnson to pay $2.1 billion to a number of plaintiffs alleging the company's baby powder was contaminated with carcinogenic asbestos.
And while Johnson & Johnson announced in February that it had set aside $3.9 billion to cover litigation costs related to baby powder, the actual payment of these settlements will result in dramatically lower GAAP EPS for Johnson & Johnson in the near future.
Johnson & Johnson produced $8.03 in adjusted diluted (non-GAAP) EPS in 2020 against $3.98 in dividends per share, which equates to a reasonable 49.6% adjusted diluted EPS payout ratio -- striking a healthy balance between rewarding shareholders in the present and investing for future growth to fuel dividend increases moving forward. And it's especially impressive in the down year of 2020, in which adjusted diluted EPS declined 7.5% year over year.
Johnson & Johnson is forecasting that it will generate adjusted diluted EPS of about $9.50 in 2021, and plans to pay dividends per share of $4.19, for an adjusted diluted EPS payout ratio of 44.1%.
An unparalleled balance sheet
So the payout ratio looks good. What about the balance sheet?
One of the more useful metrics we can examine in Johnson & Johnson's case is the interest coverage ratio, which measures a company's ability to cover its interest expense with earnings before income taxes (or EBIT). This is important to consider because a higher interest coverage ratio makes it less likely that a company will go bankrupt when it falls on difficult times.
Johnson & Johnson's interest coverage ratio was a robust 155 in first-quarter 2021 ($7.4 billion in EBIT/$48 million in net interest expense), which is considerably higher than peers' -- AbbVie, for example, has an interest coverage ratio of six, and Pfizer's is at 17.
That's even more impressive when you consider that the Q1 number was actually a weakening over Q1 2020, when the company generated net interest income of $42 million, making its interest coverage ratio technically infinite. The change was due to both a decline in interest rates on Johnson & Johnson's cash and marketable securities positions, and a higher debt balance ($27.6 billion in Q1 2020, compared with $33.6 billion in Q1 2021).
These numbers help to explain why Johnson & Johnson stands alone in the healthcare industry with its flawless AAA credit rating from major ratings agency S&P Global. It and Microsoft are the only two publicly traded U.S. companies with flawless credit ratings.
While management will need to be measured with its acquisitions and share repurchases going forward to keep its flawless credit rating, Johnson & Johnson's extremely high interest coverage ratio will allow the company to continue to deliver solid dividend increases for years to come.
A steady business mix
Finally, you can't argue with this company's business mix -- or its brand power. Johnson & Johnson has three divisions: Pharmaceuticals, medical devices, and consumer health. Pharmaceuticals, including Johnson & Johnson's COVID-19 vaccine, comprised 54.7% of net revenue in Q1 2021.
Medical devices (including joint replacement and spinal care products) brought in 29.5%, and consumer health -- the segment behind household names like Tylenol and Listerine -- contributed 15.9%. Overall, net revenue was up 0.6%, to $82.6 billion, in 2020.
Now that elective procedures and office visits have resumed throughout many parts of the U.S. and the world, the medical devices and pharmaceutical segments have rebounded. In Q1 2021, revenue for these divisions increased by 10.9% and 9.6%, respectively, year over year. Meanwhile, revenue for the consumer health segment was down 2.3% in the same time frame, with people no longer loading up their medicine cabinets during a pandemic.
Their performance during and after the pandemic shows that Johnson & Johnson's three segments are able to execute a delicate balancing act, regardless of the operating environment, to drive respectable operating results -- and provide future dividend increases.
The past looked good, the future looks great
Johnson & Johnson's storied legacy as a Dividend King is appealing to an investor, but its future should be even more appealing. The company's payout looks secure, its interest coverage ratio is very strong, its AAA credit rating is unparalleled in the healthcare industry, and the steady business mix should allow the company to continue its dividend growth for many years. Investors who are looking for both safety and moderate growth potential would be wise to put Johnson & Johnson on their watch list and await a dip to below about $160 per share.
