Should You Buy the Dow — Johnson & Johnson

Today, we’re looking at Dow Jones Industrial Average component Johnson & Johnson (NYSE:JNJ). One of the truly remarkable things about this 125-year-old company is that it makes just about everything.

I’m not kidding. Not only does Johnson & Johnson make a bunch of consumer products — it actually makes medicines and medical devices, too.

The Consumer segment provides products used in baby care, skin care, oral care, wound care and women�s health care fields, as well as nutritional, over-the-counter pharmaceutical products. The Pharmaceutical segment offers drugs in these areas: anti-infective, antipsychotic, contraceptive, dermatology, gastrointestinal, hematology, immunology — I�m getting sick just listing them all — neurology, oncology, pain management and virology. The Medical Devices segment offers circulatory disease management products, as well as orthopaedic joint reconstruction, spinal care and sports medicine products. The list goes on and on.

JNJ’s diversified product line insulates it against economic downturns, but because it is focused on health care, Johnson & Johnson is insulated even more. Folks, you need Band-Aids in good times and bad. And pain relief. And if you’re sick enough to need those drugs, you’ll still need them. There is competition out there, though, so JNJ relies a lot on its brand name. Still, Johnson & Johnson has to do battle with generic and private label competition, and as grocery stores offer their own versions of, well, just about everything, Johnson & Johnson has been facing some headwinds.

Johnson & Johnson carries a dragon’s lair of wealth: $29.6 billion in cash and only $13.7 billion in debt, at an interest rate of about 5%. Trailing 12-month cash flow was an astonishing $12.5 billion, so the debt service is no problem. JNJ also had twice the amount of free cash flow necessary to pay its 3.6% dividend.

We generally don’t see venerable companies like this have many insider trades, but one director did buy 1,000 shares of JNJ in August.

Conclusion

Stock analysts looking out five years on Johnson & Johnson see annualized earnings growth at 5.6%. At a stock price of $58 (backing out net cash), on FY 2011 earnings of $4.97, JNJ stock presently trades at a P/E of 11.6. Given its growth rate is half that, the stock seems pricey.

If we put an 8 P/E on Johnson & Johnson, I think we are giving it a deserved premium considering its consistent history of free cash flow and brand name. On projected 2015 earnings of $6.87 per share, we get a price target of right about $55. Uh oh. Looks like JNJ stock is fairly priced — and beyond. And when a stock exceeds fair value, I suggest selling.

• I believe JNJ is a sell for regular accounts.
• I believe JNJ is a sell for retirement accounts.

As of this writing, Lawrence Meyers did not own a position in any of the aforementioned stocks. Check out Meyers’ take on other Dow Jones stocks here.