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Better Buy: Johnson & Johnson or All 30 Dow Jones Stocks?

By James Brumley – Nov 26, 2021 at 9:19AM

Key Points

  • J&J shares have not responded well to news that the company is planning a spinoff of its consumer health arm.
  • This split, however, will bring clarity to investors that may be struggling to measure the true strength of Johnson & Johnson's drug business.
  • Meanwhile, the Dow Jones Industrial Average is positioned to suffer a pullback.

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As is usually the case, the decision requires looking at both options through a case-by-case lens.

Shares of healthcare giant Johnson & Johnson (JNJ -0.78%) have lagged the broad market since last year's low, but they've been outright poor performers since peaking in August of this year. The stock is down 10% for the past three months, and back within sight of multi-week lows hit in early October. Not even word that the company intends to spin off its slow-growing consumer health business was able to light a fire under the stock.

Ergo, investors with some idle money ready to be put to work could easily conclude that something more broad-based like the SPDR Dow Jones Industrial Average ETF Trust (DIA -0.26%) is a better bet than the individual component of the Dow Jones Industrial Average (^DJI -0.25%) itself is right now. After all, the Dow remains within reach of record highs hit earlier this month, and is seemingly still going strong.

That simple performance-based comparison, however, looks past a couple of important investing lessons nobody can afford to ignore.

Why Johnson & Johnson?

There's the Johnson & Johnson you know... baby shampoo, Band-Aids, Tylenol, and a whole host of other over-the-counter products you likely have in your home right now. Then there's the J&J you may not know. In addition to several surgical products, the company is also the name behind prescription pharmaceuticals like cancer-fighting Imbruvica, and Stelara for treating psoriasis. As one might suspect, the company's consumer goods business is reliable, but low growth. At the other end of the spectrum, Johnson & Johnson's prescription drug business is packed with potential growth, but not necessarily a predictable producer.

Management feels these two disparate types of business lines ultimately work against the stock's price, as investors aren't sure how to value their combination. The announcement of the split even explains that the planned breakup will allow for a "compelling financial profile that more accurately reflects the strengths and opportunities of each business."

It's an "unlocking value" argument investors have heard before, often right before corporate splits that lead to short-term gains at the expense of long-term success. That may be why the stock hasn't responded all that bullishly to the news.

In this particular case, though, the argument is on target.

Metallic dice with face sides showing "buy" and "sell" lying on a stock chart.

Image source: Getty Images.

J&J's consumer health business accounts for about 16% of its top line, versus 29% for its medical device arm and 55% for its prescription drug business. We know the drug and device units are growing faster, but it's not necessarily consistent growth. And we also know that while it drives 16% of its revenue, the consumer goods arm only makes up about 6% of the company's profits. Pharmaceuticals, meanwhile, account for about three-fourths of Johnson & Johnson's earnings. It would be surprising if the market was willing to price the stock above its lowest possible/plausible valuation.

Even so, right now the whole is still priced less than the sum of its parts. Regardless of how the intended split divvies up sales, earnings, assets, and liabilities, new investors can plug into an enterprise that is currently priced at only 16.4 times this year's projected profits, and a mere 15.5 times next year's earnings estimates. A breakup only ups the odds that Johnson & Johnson's distinct arms will be able to top their current collective profit estimates; there's much to be said for being able to focus.

Simply put, most investors are missing the bigger picture with J&J.

The kicker: Investors may also be missing the fact that the company's got 14 drugs currently in development that could generate an average of $4 billion each at their peak. For perspective, Johnson & Johnson sold $45.6 billion worth of prescription pharmaceuticals in 2020.

Why not the Dow?

None of this is to suggest owning the Dow via a mutual fund or ETF is an awful idea, particularly if you're a long-term investor. 

While the market as a whole (and the Dow Jones Industrial Average in particular) is overbought and ripe for a pullback, the pullback we're due isn't a full-blown bear market. It's only a garden variety correction in the cards. They happen, and they're always overcome sooner or later. If you're currently holding an index-based instrument, the tax consequence of selling it could far outweigh any upside of bailing out of it now.

If you're talking about a new trade with undeployed cash, however, the Dow's 100% gain from last March's low leaves it just a little too ripe for profit-taking. In fact, the Dow has led the market lower since its early November peak, suggesting its blue chips are the stocks investors are already looking to take profits on first. Take the hint.

James Brumley has no position in any of the stocks mentioned. The Motley Fool recommends Johnson & Johnson. The Motley Fool has a disclosure policy.

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