Research and development is an important metric to consider when looking for consumer goods stocks that will outperform the market for many years to come. Not only does research and development give companies a competitive edge against rivals, but it also helps them pioneer new product categories that in turn fuel revenue growth. Analysts are torn on whether R&D spending should be classified on the income statement as an investment or as an expense.
However, the important thing for investors is to find companies that strike a balance between rewarding shareholders through dividends and share buybacks, while also investing aggressively in product development and R&D. Enter Johnson & Johnson (NYSE:JNJ).
Investing in the future
In fiscal 2014, Johnson & Johnson spent an eye-popping $8.5 billion on research and development -- an increase of 3.8% from the prior year. That translates into more than four times what its closest consumer products competitor, Procter & Gamble (NYSE:PG), spent over the same period.
However, one critical distinction between J&J and Procter & Gamble is that in addition to its consumer goods business, Johnson & Johnson also has a robust healthcare and pharmaceutical business. This is why, even as an iconic consumer products company with brand names like Band-Aid, Neutrogena, Aveeno, Rogaine, Listerine, Bengay, Tylenol, Benadryl, Nicorette, Pepcid, Motrin, Splenda, Lactaid, and Visine, J&J must spend nearly four times as much on R&D as its closest consumer goods rivals.
Last year, Johnson & Johnson spent more than 11% of total sales on R&D. The bulk of that went to the pharmaceutical business, with R&D spending totaling 19.2% of segment sales. Meanwhile, R&D spending totaled 6.0% of sales for the medical devices segment and 4.3% of sales for the consumer products business.
Nevertheless, Johnson & Johnson continues to focus meaningful R&D resources on its consumer business as well as its healthcare and medical device segments today. Last year, the company launched several new consumer and over-the-counter products including women's Rogaine, various new formulas of Listerine, and relaunched innovative versions of key brands like Tylenol PM. "Our insight-driven innovation in the consumer business is focused on addressing key consumer need states, led by our 12 megabrands, with 20 new product launches planned for 2015," said chief executive Alex Gorsky.
Thanks to its constant innovation, Johnson & Johnson has been creating superior shareholder returns for over 129 years. Moreover, the company's strategy of pouring loads of cash into its R&D efforts is still paying off nicely for Johnson & Johnson. In fact, new products that the company rolled out within the past five years accounted for as much as 25% of J&J's sales last year.
J&J is also spreading its R&D spending equally across its various businesses. In fiscal 2014, for example, no single project represented more than 5% of the total annual budget for research and development.
A balanced approach
With a balance sheet that boasts $33 billion in cash and cash equivalents, J&J's cash stash should be able to support both its annual dividend of $2.76 per share, as well as continued R&D spending in the quarters ahead. The conglomerate's rich history of dividends and buybacks also tells us that the company isn't sacrificing shareholder returns to boost its R&D spending.
In addition to paying a dividend every year for the past 71 years, the company has also increased its dividend for the last 52 years without fail -- earning it the coveted title of dividend aristocrat. The stock's payout ratio of 38% is another positive because it tells investors that for every dollar the company earns in net income, 38% is being returned to shareholders as a dividend. That is both reliable and rewarding at its current level.
Not only is Johnson & Johnson committed to shareholder returns through dividends, but it also stands tall as a growth stock today thanks to its focus on innovation and industry-leading R&D initiatives. With strong cash generation to back it up, investors can expect J&J to be a market leader for many more years to come.