Neutral On Johnson & Johnson's Bullish Technical Indicators And High Dividend Yield

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Johnson & Johnson (NYSE: JNJ) ranks as the world’s largest and most diverse healthcare company. The company has three divisions: Pharmaceutical, Medical Devices and Diagnostics, and Consumer. While the pharmaceutical division currently represents close to 36% of total sales, we expect patent losses and the Synthes acquisition to reduce this proportion to approximately 27% during the next 10 years. Subsequently, the device segment will be picking up the majority of the share.

Johnson & Johnson (JNJ) stands as the leader across the major healthcare industries. The company maintains a diverse revenue base, a robust research pipeline, and an exceptional cash flow. The said characteristics of the company create a wide economic moat. As of press time, the stock closed at $71.78. In the past year, the stock has hit a 52-week low of $61.05 and 52-week high of $72.74. Technical indicators for the stock are bullish and the company’s fundamental ratios are strong.

GROWTH AND BALANCE SHEET

For the third quarter of 2012, JNJ reported EPS of $1.25, four cents better than analyst estimates, and 1 cent better than last year. Sales of $17.1 billion were slightly higher than estimates of $16.95 billion, and 6.5 percent higher than last year’s revenue of $16 billion. The company’s annual earnings growth rate over the past five years is -1.3%. The total debt to equity of 30.7% stands at reasonable level and below the industry’s average.

 More on JNJ valuation after the JUMP!

VALUATION

Johnson & Johnson is widely recognized as one of the highest quality blue-chip dividend paying stocks on the planet. For the first nine months of 2012, Johnson & Johnson reported revenues of $49.7 billion. The market currently values Johnson & Johnson at $198 billion. This values the firm at 3.0 times annual revenues and 18 times annual earnings.

JNJ has a PEG ratio of 2.31, above the industry average. The P/E of 23.51 is not attractive and above the industry average. The stock is currently trading below its fair value of $77. The beta of 0.49 implies very low volatility of the stock with respect to the S&P 500. Johnson & Johnson pays a quarterly dividend of $0.61 per share, for an annual dividend yield of 3.4%.

RECOMMENDATION for next 6 months: We initiate our coverage with NEUTRAL. The company has demonstrated a pattern of bullish technical signs and steady earnings performance. Shares are up 9.45% year to date as of the close of trading yesterday.

NEWS and CALENDAR

Tuesday October 23, 2012 – Johnson & Johnson CFO Sells 20.4K Shares

Tuesday October 15, 2012 4:58 PM – J.&J.’s Costs Take a Toll on Its Profit

Tuesday October 9, 2012 11:00 AM – Goldman Sachs Downgrades Johnson & Johnson (JNJ) to Sell, Sees Limited Upside

Strengths vs. Weaknesses

JNJ is a trusted brand with strong distribution chain and diverse business. However, continuous product recalls hurt the brand name and its profits. Private label goods and generic competition hurt the company’s premium products.

Stock Valuation Model

The model rates stocks from 1 to 10, with 10 being the best using a system of advanced mathematics to determine a stock’s expected risk and return. I am using different fundamental and technical factors in order to rank a stock.

Intrinsic Value

Investors should buy stocks selling at a discount to their intrinsic value, and then patiently wait for the fair value of their investments to be realized.

JNJ’s intrinsic value is $77.00 the current price is $71.78, the stock trades 7% below it’s fair value.

Financials

The financial health of the company the higher the better, we evaluate all the financial ratios of the company.

Sentiment

This refers to the investor’s sentiment on the stock.

Analyst ratings

The model assigns a value according to analyst’s recommendation for the stock.

Earnings Consistency

Each year’s EPS numbers should be better than the previous year’s. One dip is allowed, but the following year’s earnings should be a new high. JNJ’s annual EPS before extraordinary items for the last 5 years (from earliest to the most recent fiscal year) were 3.63, 4.57, 4.40, 4.78, 3.48. This type of earnings action is not favorable.

Total Debt to Equity

The company must have a low debt to equity ratio, which indicates a strong balance sheet. The debt to equity ratio should not be greater than 20% nor should it be less than the average debt to equity for its industry.

JNJ’s total debt to equity ratio of 30.70% is acceptable because it is below the industry’s average of 52%.

Quarterly EPS Change

The EPS growth for this quarter relative to the same quarter a year earlier is above the minimum 18% that this model likes to see for a good growth company.

JNJ’s EPS growth for this quarter relative to the same quarter a year earlier is -8.70% and this is well below our target.

Annual Earnings Growth

This model looks for annual earnings growth above 12%, but prefers higher than 20%.

Johnson & Johnson annual earnings growth rate over the past five years is -1.30%, and this is below our target growth.

Current Price Level

Traders should keep an eye open for stocks that are trading within 10% of their 52-week highs, as it is likely to continue in its upward trend.

JNJ’s 52 week high is $72.74 current price is $71.78, only 1% below the 52 week high.

P/E Ratio

The price to earnings ratio, based on the greater of the current P/E or the P/E using average earnings over the last 3 fiscal years, must be moderate. This means it is not greater than 15. Stocks with moderate P/E are more defensive by nature.

The company has a P/E ratio of 23.51 while the average industry P/E ratio is 16.39 and well above the S&P 500 P/E ratio of 17.00.

Insider Ownership

When there is strong insider ownership which I define as 12% or more, management is more likely to act in the best interest of the company, as their interests are right in line with that of the shareholders.

Insiders own 0.04% of JNJ stock. Management’s representation is not large enough. This does satisfy the minimum requirement, and companies that pass this test are more attractive.

Technical Analysis

I am using several technical indicators (MACD, RSI, MFI, OBV, position indicators) to forecast the trend of the stock for 6 and 12 months, and assign a value.

The Commodity Channel Index (CCI) is bullish for JNJ. The prices have formed bullish MACD Crossover signal. Our indicators give bullish signs for the short term and for the intermediate term on JNJ.