A simulation-based valuation of Johnson & Johnson (JNJ): September 2019

Summary

- JNJ () manufactures and sells various health care products worldwide, primarily in three segments: pharmaceuticals, medical devices, and over-the-counter products.

- It had a market capitalization of $347.45 billion at the time of this writing, and an attractive dividend yield of 2.89%.

- JNJ has a comfortable payout ratio of 30.11%. It has an attractive balance sheet, with $15.3 billion in cash.

- In this post we provide a simulation-based (sim-based) valuation of JNJ.

- Our sim-based analysis suggests that the fair price-to-earnings ratio should be 23.22, leading to a current fair value of $140.02.

- JNJ currently trades at $131.65, so it appears be undervalued, with a potential upside of 6.36%.

- The potential upside could possibly be much higher, given that JNJ’s price-to-earnings ratio for the past 5 years has been on average 76.05.

Johnson & Johnson (JNJ)

JNJ manufactures and sells various health care products worldwide, primarily in three segments: pharmaceuticals, medical devices, over-the-counter products. JNJ had a market capitalization of $347.45 billion at the time of this writing, and an attractive dividend yield of 2.89%.

Estimating a fair value for the stock

In this post we provide a simulation-based (sim-based) valuation () of JNJ.

At the time of this writing the company had a trailing twelve months price-to-earnings ratio of 21.83. The growth in earnings for the past 5 years has been on average a relatively low 3.12%, but has recently (trailing twelve months) shot up to 43.45%. To be conservative, we will consider the mid-point between these two numbers, or 23.28%, to be the sim-based earnings growth rate for the next 5 years.

Is the price-to-earnings ratio of 21.83 suggestive of undervaluation? As you can see in the table below, the answer to this question seems to be “yes”. Since our sim-based analysis uses a S&P 500 return as a basis, the fair price-to-earnings ratio should be 23.22, leading to a current fair value of $140.02. JNJ currently trades at $131.65, so it appears to be undervalued, with a potential upside of 6.36%.

Is the fair price-to-earnings ratio of 23.22 too high?

Could the fair price-to-earnings ratio estimated above, of 23.22, be too high? Arguably the answer is “no”, because JNJ’s price-to-earnings ratio for the past 5 years has been on average 76.05. In fact, given this, our potential upside may be underestimated.

JNJ typically trades at a premium because of its dominant position in the health care industry. Also, like many consumer defensive stocks, it is considered to be a low-risk investment that holds up well during economic downturns.

Other pluses and minuses

JNJ pays an attractive dividend of 2.89%, higher than the average S&P 500 dividend, and with a comfortable payout ratio of 30.11%. It has an attractive balance sheet, with $15.3 billion in cash, although it has $29.4 billion in debt.

This debt is not as problematic as it may seem, because JNJ’s income before tax is approximately $18 billion. That is, the combination of cash and income before tax exceeds JNJ’s debt, which means that the company can pay down its debt in a relatively short amount of time should it need to do so.

Recently in one of the first state opioid cases, an Oklahoma judge ruled against JNJ, awarding the state $572 million. This was well below the over $17 billion the state was seeking in damages, and JNJ is going to appeal. This is generally good news.

Disclosure

The author owns JNJ shares at the time of this writing.