Recent performance for Johnson & Johnson's (NYSE: JNJ) has been pretty dismal. Not only has the stock slipped in price over the past 12 months, but it has badly outperformed the broader market.

Though the stock has generally not had much pep in its step over the past year, it's gotten hammered in recent months as investors reacted to a string of product recalls. Of course not all investors have been scared off -- recent SEC filings from Berkshire Hathaway (NYSE: BRK-B) show that Warren Buffett added more than $1 billion worth of J&J stock to the company's portfolio during the second quarter.

Shares of J&J currently change hands right around $58 per share. Is that a good deal? Well, first we need to get an idea of what J&J's shares are really worth.

It's a beautiful day in the neighborhood
One way to get an idea of what a stock might be worth is to check out how similar companies are valued. So let's take a look at how J&J stacks up.


Total Enterprise Value / Trailing Revenue

Price / Forward Earnings

Price / Book Value

1-Year Forward PEG

Johnson & Johnson










Abbott Laboratories (NYSE: ABT)





Bristol-Myers Squibb (NYSE: BMY)





Eli Lilly (NYSE: LLY)










Pfizer (NYSE: PFE)





Stryker (NYSE: SYK)










Source: Capital IQ, a Standard & Poor's company, and Yahoo! Finance.
Average excludes Johnson & Johnson.
NM = Not meaningful. Eli Lilly projected to have negative growth.

Using each of those averages to back into a stock price for J&J, and then taking the average across those results, we can come up with an estimated price-per-share of right around $58. This would suggest that J&J seems to be fairly valued.

Looking more closely at the chart though, we can see that all of J&J's multiples exceed the group average, except when it comes to the PEG ratio. Checking out the underlying data, J&J's expected growth is among the best in the group, significantly topping companies like Pfizer and Eli Lilly. To me, this suggests that while J&J may see better growth than many other major pharma names, investors have been giving it a very small premium for that extra growth.

While this may be partly due to J&J's recall issues, much of the pharma group have seen their stocks muddle along since the beginning of the year when J&J's recalls began.

Collecting the cash flow
An alternate way to value a stock is to do what's known as a discounted cash flow (DCF). Basically, this method projects free cash flow over the next ten years and discounts the tally from each of those years back to what it would be worth today (since a dollar tomorrow is worth less to us than a dollar today).

Because a DCF is based largely on estimates (aka guesses) and it attempts to predict the future, it can be a fickle beast and so its results are best used as guideposts rather than written-in-stone answers sent down from Mount Olympus.

For J&J's DCF, I used the following assumptions:

2009 Unlevered Free Cash Flow:

$16 billion

FCF Growth 2010-2014:


FCF Growth 2010-2019:


Terminal Growth:


Market Equity as a Percentage of Total Capitalization:


Cost of Equity:


Cost of Debt:


Discount Rate:


Source: Capital IQ, a Standard & Poor's company, Yahoo! Finance, author's estimates.

While most of this is pretty standard fare when it comes to DCFs, the academically inclined would probably balk at the way I set the cost of equity. In a "classic" DCF, the cost of equity is set based on an equation that uses beta -- a measure of how volatile a stock is versus the rest of the market -- and a few other numbers that I tend to thumb my nose at.

But when you get right down to it, the cost of equity is the rate of return that investors demand to invest in the equity of that company. So I generally set the cost of equity equal to the rate of return that I'd like to see from that stock.

Based on the assumptions above, a simple DCF model spits out a per-share value of $82 for J&J's stock. This would seem to suggest that this blue-chip behemoth is pretty significantly undervalued.

Do we have a winner?
The valuations that we've done here are pretty simple, and, particularly when it comes to the DCF, investors would be well advised to play with the numbers further before making a final decision on J&J's stock.

That said, the range of $58 to $82 that we got from the two valuation methods seem to say that J&J's stock is fairly valued to significantly undervalued. At the midpoint between the two estimates we get $70 -- a full 20% above J&J's current price.

As a shareholder myself, I lean more toward the DCF's higher estimate and think that Buffett may have been looking at some similar arithmetic when he made his big buy last quarter. Quite a few prominent investors have been highlighting the bargain-basement valuations on U.S. blue chips and I think this may be a prime example. My fellow Fool Alex Dumortier has also taken a look at the blue chip issue and has offered some possible explanations for these blue chip deals.

Do you agree that J&J's stock is on sale? Head down to the comments section and share your thoughts.

Even if you're busy buying blue chips for your portfolio, some well chosen shorts may be just what your portfolio needs.

Berkshire Hathaway, Pfizer, and Stryker are all Motley Fool Inside Value recommendations. Berkshire Hathaway is also a Stock Advisor choice, and the Fool owns some shares. Johnson & Johnson is an Income Investor recommendation, and Motley Fool Options has recommended a diagonal call position on its shares. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Matt Koppenheffer owns shares of Berkshire Hathaway, Abbott Labs, Eli Lilly, and Johnson & Johnson, but does not own shares of any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.