Investing in pharmaceutical stocks can be especially lucrative. But investors need to be sure that they are picking underlying companies with both exceptional drug portfolios and pipelines. That's because this translates into a stable and growing revenue base, which can power earnings higher as well.
While there is no perfect dividend stock, Johnson & Johnson (JNJ 0.67%) is about as great as they come. Let's delve into the Dividend King's fundamentals and valuation to articulate what makes the stock a buy for income investors.
Improved profitability catapulted earnings higher
Since its founding more than 130 years ago, J&J established itself as the leading pharmaceutical company in the world. Just how big is J&J? The company's $429 billion market capitalization is nearly $100 billion greater than the $333 billion market cap of the next biggest peer, Eli Lilly (LLY -0.64%).
J&J's sales declined 4.4% year over year to $23.7 billion during the fourth quarter ended Dec. 31. At first blush, the company's results seem to be disappointing. But these were decent results considering the circumstances.
J&J's international sales presence in most countries around the world is generally a net positive for the company because it provides geographic diversification and room for future sales growth. But since the U.S. dollar is exceptionally strong against foreign currencies of late, J&J faced a 5.3% headwind to sales from foreign currency translation for the quarter. This is how the company produced 0.9% operational sales growth in the fourth quarter.
And when accounting for the reduced demand for J&J's COVID-19 vaccine compared to the year-ago period, the company's non-COVID-19-related sales were 4.6% higher in currency-neutral terms. These solid results were mostly driven by 10.9% operational sales growth within the oncology division of J&J's pharmaceutical segment. The company's sizzling growth was led by double-digit growth in the smash-hit drug Darzalex and the blockbuster drug Erleada. Strong showings from these drugs were able to offset much of the single-digit operational sales declines in other divisions like immunology and cardiovascular and metabolism.
J&J's non-GAAP (adjusted) diluted earnings per share (EPS) surged 10.3% over the year-ago period to $2.35 during the fourth quarter. Thanks to tight cost management, the company's non-GAAP net margin soared 330 basis points higher to 26.2%. Paired with a 0.8% reduction in J&J's outstanding share count, this explains how adjusted diluted EPS grew at a much faster rate than sales for the quarter.
The future also looks bright for the company: J&J has more than 100 indications that are currently in different stages of clinical development in numerous therapy areas, including cardiovascular and metabolism, immunology, and oncology. This is why the analyst expectation of 3.9% annual adjusted diluted EPS growth through the next five years could prove to be a lowball estimate.
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The dividend is safe and generous
Compared to J&J's 2.7% dividend yield, the S&P 500 index's 1.6% yield looks underwhelming. And the dividend appears to have healthy growth in its future.
J&J's dividend payout ratio was quite manageable at just 43.8% in 2022. This should leave the company with the capital necessary to fund future research and development, acquisitions, and debt repayment to further strengthen the business. That's why I believe that the dividend will be able to grow moderately ahead of earnings for at least the next several years, extending the growth streak beyond the current mark of 60 consecutive years.
J&J has faced legal trouble in recent years in its consumer health segment from lawsuits alleging that its talc-based baby powder contributed to cancer in claimants. This is a large part of the reason why the company decided to spin off its consumer health segment to create a separate company named Kenvue. The spinoff should be completed around November of this year.
J&J's dividend payout may look a bit different once the spin-off is completed. This is because the company's consumer health segment accounted for nearly 16% of its revenue in 2022. That is why J&J's dividend will likely have to be reduced a bit to compensate for the loss of its consumer health segment. But the company has vowed that shareholders will be made whole by the separate dividend that will be paid by Kenvue after the spin-off is completed.
An attractive valuation
J&J is a world-class company, although this isn't reflected in the stock valuation. The stock's forward price-to-earnings (P/E) ratio of 15.7 is below the S&P 500 healthcare sector forward P/E ratio of 16.9. As J&J moves closer to the completion of its spin-off, the company could unlock value for shareholders. That's because management will be able to prioritize the typically faster growth and more profitable pharmaceutical and medtech businesses as a stand-alone company. These factors arguably make J&J a no-brainer buy for dividend growth investors at the current $165 share price.
