Why I’m not buying Johnson & Johnson

If there’s one stock that seems to be on just about everyone’s list of recommended dividend stocks it’s Johnson & Johnson (JNJ: 58.70 -0.39%, yld: 3.50%). It’s not hard to understand why – it’s a great company with consistent earnings and dividend growth, and the stock so far has significantly outperformed during what has been for most stocks a horrific bear market.

JNJ is a dividend star
I’d love to own JNJ too. Looking back, it’s clearly been one of the best dividend stocks to have owned over the past several decades and it’s one of only about 60 elite stocks comprising the S&P 500 Dividend Aristocrats – stocks whose dividends have increased every year for at least 25 consecutive years. (The list just got a bit shorter with Bank of America (BAC) and Pfizer (PFE) recently announcing dividend cuts.)

Likewise, DividendInvestor.com gives JNJ a maximum DividendAllStar ranking of five stars, with the company showing 46 years of consecutive dividend increases and a five-year-average dividend growth rate of 13.6%. Barring a Pfizer-like acquisition or some unforeseen earnings catastrophe that would cause it to cut its dividend, JNJ’s dividend seems secure – the company’s dividend payout ratio (the annual dividend per share divided by the annual earnings per share) is only about 40%.

Fundamentally, it’s just OK
So, with the stock now trading in the $56-$57 range, off about 20% from its highs, I thought I’d check to see if it had fallen to a level where I was comfortable buying it. Plugging the symbol into a couple of online discounted cash flow (DCF) valuation calculators – ValueCruncher and ValuePro – and using their default input values, I get back nominal intrinsic values for JNJ of about $94 and and $129, respectively!

Knowing that these types of models often use optimistic assumptions (like assuming an unsustainably high earnings growth rate forever) I don’t get too excited seeing numbers like these. But they do suggest that the stock is at least not overvalued at current levels.

For a more conservative valuation, I use the moneychimp DCF calculator and enter in a 0% longer-term earnings growth rate and, in this case, an expected growth rate of 8% for the next five years (based on projections for JNJ from Value Line). Lo and behold, I get an intrinsic value of $57 – just about exactly where the stock is currently trading. Needless to say, I’m only interested in buying stocks at levels well below their fair value, so this is a bit of a cooler.

To get another take on the stock’s valuation, I plugged it into the fundamental analysis tool at Ockham Research, which compares a stock’s current valuation ratios with historical minimum and maximum values to determine whether it’s now relatively under- or overvalued from an historical perspective. The bottom line here is that JNJ is relatively expensive from a price/sales and price/cash earnings perspective, but that its higher-than-average dividend yield (compared to recent history) is a positive.

Technicals say caution may be in order
Fundamentally, then, JNJ currently appears to be about fairly valued – maybe a little on the expensive side. Technically, however, the stock price is well above its long-term linear regression trendline at about the $50 level (see 38-year chart below), which suggests that it could easily trade down into the 40s or even 30s and still remain within its long-term uptrend channel.

This isn’t a prediction – only an attempt to gain some longer-term perspective on the stock price and assess the potential degree of downside risk from a long-term investment point of view. A final additional clue may suggest caution as well.

Although the Ockham research cited above found JNJ’s dividend yield high compared to recent history, the top graph in the chart above (showing the annual dividend yield) shows that even as recently as 1994 the stock traded at a yield of about 4% – which would mean a price level of $46 today. A yield of 5% or 6%, as was seen in the 1980s, would mean a price of about $37 or $31, respectively.

Bottom line
I’m not currently tempted to buy Johnson & Johnson at its current levels. But it’s been a long-time buy candidate on my watchlist and remains so. I’ll become very interested if it drops to the $40-$45 level or below.