Hey YouTube.
I'm Jimmy and this video.
We're gonna walk through my analysis of Johnson and Johnson ticker symbol JNJ.
This video continues our series or analyzing all 30 stocks in the Dow
Jones industrial average with the ultimate goal of taking that analysis and trying
to build three different portfolios a value portfolio a growth portfolio a dividend
portfolio.
This is the 16th video in that series.
It could see a link in the description below.
To all of the other 15 videos.
OK let's break down Johnson and Johnson's business.
So as I'm sure you know Johnson and Johnson makes a ton of different
products but in twenty seventeen it surprised me to learn that their
consumer products division only accounted for about 18 percent of revenue.
Then we could see their second largest segment is medical devices and diagnostics.
And then finally the largest segment is pharmaceuticals which accounts for about 47 percent of revenue.
Now when we look at historical revenue by segment we could see
that pharmaceuticals has gradually increased its dominance over the other two categories.
And we could see that revenue from consumer products has gradually declined over the past few years.
There are the gray bars and medical devices dip lower from 2013 to
about 2015 and it looks like they're starting to head higher again.
So I thought this is interesting and maybe it's just because
I haven't researched Johnson and Johnson in a while, So it surprised me.
And when I first set out to start the research I
was thinking consumer products consumer staples something reliable a defensive play.
Now I realize that they're much more of a pharmaceutical company than I originally expected.
That being said it looks like competitors for them would be close to companies like Pfizer and Merck.
The main difference is that companies like Pfizer and Merck have about 90 percent of their
revenue from pharmaceuticals while we can see that Johnson and Johnson only has about 50 percent.
Now this makes JNJ more of a diversified pharmaceutical company which I think is a good thing.
But this brings us to some of the risks.
Some recent developments and then after that we'll dive into the valuation of JNJ stock.
OK.
So currently JNJ is in litigation with more than 10000 personal injury lawsuits
over claims that one of their pharmaceutical drugs causes ovarian cancer
although lawsuits filed total more than it's like one hundred billion
dollars.
Many analysts believe that JNJ is going to settle many of those suits and they're
going to end up paying somewhere near let's say 10 billion dollars maybe less.
Now this isn't necessarily crazy news since pharmaceutical companies are always getting sued
and I understand that many people don't like the morality or lack of
morality of pharmaceutical companies and that being said with this video I'm trying
to focus on how investable the business is from a numbers perspective.
And for those of us who don't like pharmaceutical companies I completely understand
OK going back to the analysis now as far as the numbers go.
There was also recently a court filing that Johnson and Johnson wasn't going
to be able to block the generic version of ZYTIGA Zytiga.
I'm not sure how to pronounce it.
This doesn't necessarily hurt earnings but hurt and hurt expectations of
earnings because many analysts already projected a dip in revenue from
three point four billion in 2018 to two point three billion
2019.
Okay now let's see how overall revenue is done.
Here's a chart of revenue going back to 2010.
And as you could see revenue pulled back in 2015 and then began moving higher again.
When we throw in expectations we could see that revenue is expected to continue to climb higher over the next few years.
When we switch net income we could see that this story looks somewhat similar.
A pullback in 2014 and 2015 started moving higher again pull
back last year projections have been moving higher in the future.
Now if we look at their US gaap financials you may see that 2017 profit.
There was a huge drop in profit.
The reason for this was that the new tax bill had changes in it that left JNJ on the hook for tons of taxes in 2017.
That's how you get adjusted earnings that look like this and then us gap earnings that looked like that.
I think that analysts did the right thing in making these adjustments because taxes
going forward are expected to go back in line with what they were.
That being said had the expectations for taxes been that they would remain high.
It would only make sense to do the adjustment according to what expectations were going forward.
That being said I'm okay with the adjusted earnings.
Now one of the good parts for Johnson and Johnson investors is their dividend.
This is a chart of their annual dividends going back to 2011 and as you can see
dividends have been quite consistent with the current yield of about two and a half percent.
Compare that to the S&P 500 and they have a dividend yield of just short of 2 percent.
So JNJ looks pretty good.
Now one of the questions I usually have when I see a very consistent dividend like this is
can they keep it up and one of the ways you could tell is by looking at net
income relative to dividends you can use something called the dividend coverage ratio which looks at net income.
Divide that by the dividend payment and if the result is over 1 then the company has more
than 100 percent of net income needed to make the dividend payments the higher that number the better.
The inverse of that is called the dividend payout ratio which looks at how much
a dividend well how much of a dividend was paid compared to net income.
So dividend divided by net income.
This is a dividend payout ratio for Johnson and Johnson going back to 2008.
And as we could see they've paid out about 50 percent or so of net income over the past decade.
Now this is excluding the six hundred eighty seven or so percent that was paid out in 2007 because of a tax hit.
Okay so now we know that they pay out about half of the profits as dividends.
Okay.
So my next question is now we know that they're
consistently paying our dividends and they're consistently increasing them.
The question is how much are those dividends increasing by.
And we want to know this because if they stick with a 50
percent dividend payout ratio well profits have to increase by about the same
rate in order for dividends to continue to increase at that rate.
Now this chart this is the dividend increases from year to year and we could
see that last year the increase was their lowest at about five point four percent.
If we exclude that the average of all the other years is about 7 percent a year.
So that tells us that net income needs to increase by about 7
percent over the long run in order for dividends to continue to increase
at a 7 percent rate assuming that they stick with their 50 percent
payout.
Now interestingly this is a chart of their net income percentage gains from year to year.
And as you may have expected from the net income chart that we saw before there's been some volatility here.
And this chart uses adjusted numbers.
And if we had used the gap numbers then 2017 would there would have been
an enormous drop off and then an enormous drop off our enormous gain in 2018.
So I'd like to just to use adjusted numbers now if we take this entire time period
into account including 2017 and the projections Well the average is the very same 7 percent.
That tells me that they can continue to pay that distribution increasing it by about 7 percent a year now.
Personally I believe that using estimates in this scenario makes a lot of sense
because we want a longer time period we can either go back let's say
another decade that we have we have a longer time period because we know
that there is some volatility to net income for Johnson and Johnson but the
other reason why I'm okay with using projections is because it's not like some
companies have a rule that they will pay out exactly 50 percent and instead
of increasing by about 7 percent they increase by the exact same amount every
year.
If that were the case then I would want much harder faster rules about how we're analyzing it
but in our case they're using about 50 percent profits are going up by about 7 percent.
Dividends are going up by about 7 percent.
So I'm going to say that I'm I seem fairly confident.
I personally am fairly confident with their ability to keep doing this.
This also gives us an important piece of information because if we were to buy into
this company and we're going to analyze what they do over the next let's say five
years and we analyze their net profit margins how much you know net profit margins.
If we analyze how much they're increasing net profit by each year.
Well if the number drops from 7 percent to let's say 5 or 3 or whatever the number might be.
Well we know either they're going to have to increase.
What percentage of dividends they're paying out or they're going to have
to you know decelerate the amount that they can increase dividends by.
That's important information in half.
So now the question for me is what do we think.
Johnson and Johnson stock is worth.
And once again with this type of blue chip company I really like using discounted cash flow.
So if we take free cash flow going out the next few years and we discount it by our
average weighted average cost of capital of about eight point five percent we as perpetual growth rate of 2.5
percent we end up with a fair value of about one hundred and sixty nine dollars per share.
Now if you're wondering how we calculated this we have videos from many
of the components of how to calculate this kind of cash flow.
The most common question that people ask me is how you come up with weighted average cost of capital.
And we have a video on breaking down that exact thing.
Here's the calculation that we ultimately used for WACC and to get the cost of equity.
What we did is we used what is known as the Capital Asset Pricing Model.
You could see a link to all these videos in the description below.
And if you're ever wondering if the weighted average cost of capital that you're using is a reasonable number to use.
Well you can always go back to different periods of time in the past try to calculate WACC for that time period.
This chart here.
This is a chart of WACC.
Going back to the end of 2007 and as we could see 8 percent or so seems to be about the average.
We used eight point five percent which is a bit more conservative.
Had we used 8 percent well our fair value would have jumped to about one hundred eighty five dollars per share.
And for me this speaks to the importance of trying to use more conservative numbers when coming up with the fair value.
So once we realize that that the current price is about one hundred forty five dollars a share.
Well we if we were a bit less disciplined then perhaps we could adjust our WACC to try
to make it look like a better buy or if we don't want to buy it.
Perhaps we could adjust our WACC to make it look like a worst by either way.
Knowing that the current price is one forty five our fair value estimate is one sixty nine.
We get to decide if we believe that gap that potential upside justifies is
justified by the risk we would be taking in investing in this company.
So what do you think.
Does Johnson and Johnson deserve to be in any of our ideal portfolios from a dividend perspective.
They seem quite good.
We saw that from a growth they seem OK.
We saw the 7 percent numbers that seems reasonable from a value perspective.
There seems to be some upside.
Personally I'd like it if they fell a bit more that would make it a bit more interesting.
Perhaps we get lucky and before we go ahead and build our portfolios the stock falls off.
That would make it more interesting when it comes time to actually build the portfolios.
My question to you is do you think that Johnson and Johnson stock is worth buying right here.
Let me know what you think in the comments below.
And if you haven't done so already.
Don't forget to hit the subscribe button and thanks for sticking with me all the
way to the end of the video and I'll see you in the next video.
Thanks.