Foolish investors should love boring stocks because they make great candidates for long-term investments.  These kinds of companies are in easy to understand lines of business, in stable industries, and usually have proven track records of performance. Johnson & Johnson (NYSE:JNJ) is one of these boring companies.

Johnson & Johnson is in three lines of business: consumer products, pharmaceuticals, and medical devices and diagnostics. Johnson & Johnson is the company responsible for such hits as Splenda, Band-Aids, Rogaine, and Tylenol.  To help put the analysis in perspective, we will make comparisons to The Procter & Gamble Company (NYSE:PG).  Procter & Gamble and Johnson & Johnson are both consumer goods companies in similar lines of business with market caps of $213 billion and $300 billion, respectively.

This stock pays you to wait
Johnson & Johnson sports a dividend yield of 2.7% and is considered a defensive stock.  This means that its products have stable demand and generally perform well in all economic conditions. Its share price may not skyrocket when the economy booms, but it won't go bankrupt when the market tanks either. In other words, we're always going to need Band-Aids and Tylenol regardless of the state of the economy. Procter & Gamble has a yield of 3.2% and is also a defensive stock. 

Johnson & Johnson has increased its dividend in every one of the past 51 years throughout multiple bear markets .  An impressive stat, but Procter & Gamble has increased their dividend for 57 straight years. The two companies have paid their investors to wait by rewarding them with dividend hikes and stock buybacks. But just because there is a history of dividend hikes and buybacks does not mean they are sustainable or warranted. To gauge sustainability we need to look at free cash flow (FCF), the payout ratio, and FCF coverage.

FCF coverage = FCF / (dividends + share repurchases)

Johnson & Johnson  2007 2008 2009 2010 2011 2012 2013
FCF $12.1 billion  $11.9 billion  $14.2 billion  $14 billion  $11.4 billion $12.5 billion  $13.8 billion
Payout ratio 44%  39%  43%  44%  64%  63%  53%
FCF coverage 1.18 times  1.02 times  1.9 times  1.63 times  1.31 times  0.64 times  1.28 times
P&G 2007 2008 2009 2010 2011 2012 2013
FCF  $10.5 billion $12 billion  $11.7 billion  $13 billion  $10 billion  $9.3 billion  $10.9 billion 
Payout ratio  41%  39%  38%  43%  48%  56%  57%
FCF coverage  1.07 times  0.81 times  1.02 times  1.13 times  0.78 times  0.92 times  0.87 times

Here we have a seven-year period that encompasses the lead up to the financial crisis all the way up to its supposed recovery, the most recent year-end. Over the period, the compound annual growth rate of dividends per share for Johnson & Johnson and Procter & Gamble has been 8.13% and 10.18%, respectively. Neither company has a stated dividend policy meaning management decides how much to pay out after considering the cash needed to maintain operations without straining cash balance. The table demonstrates both company's FCF generation over different market conditions, but comparing them dollar for dollar does not provide any insight.  Next we will examine payout and coverage ratios to look at dividend sustainability. 

On average, Johnson & Johnson and Procter & Gamble have paid out 50% and 46%, respectively, of earnings in dividends over the period.  High payout ratios are fine, as long as they can be maintained with increased FCFs. The payout ratio does not include share repurchases, only dividends, but FCF coverage accounts for both.  A coverage of over 1 implies that the company is not lowering its cash balance to pay for dividends and repurchases. Also, a higher ratio lets investors feel more confident that the dividends and repurchases will continue. Johnson & Johnson has been above 1 on this metric in each year except 2012, when the ratio dipped to 0.64 times. This is because the company repurchased over $10 billion in stock that year.  Usually, a repurchase of this magnitude occurs when management believes the company's stock is undervalued and is seen as a good buying opportunity. Procter & Gamble's lower payout ratio does not translate into better FCF coverage like one would expect.  Procter & Gamble has been below 1 times coverage since 2010 which implies either the dividend or repurchase program may not be sustainable.    

Foolish takeaway
The takeaway here is that Johnson & Johnson has steady FCF generation which has led to 51 years straight of dividend increases and a history of stock buybacks.  Johnson & Johnson's dividend should be viewed as safe due to their FCF generation and restraint in not paying out unnecessarily large amounts of those FCFs.  Johnson & Johnson warrants a closer look for anyone who needs a long-term dividend play in their portfolios. For Johnson & Johnson, it pays to be boring.