JNJ (NYSE)

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Johnson and Johnson (JNJ, NYSE)

I am not quite sure what people mean when they speak of a new economy or of a new paradigm in play or that using P/E ratio is no longer the way to value a company; one should be looking at price to sales or some other exotic measure. If we are to analyze something, the methods must have some permanency. Surely new generation of mathematicians are not rejecting Euclid's early theorems nor are they repealing the simple commutative law of algebra. The point being if investment is to be a rational process, rational arithmetic rules must apply. And it is the violation of the very simple rules that has me looking at boring stocks like Johnson & Johnson, not a Yahoo or Ariba. Just a few years ago, stocks such as JNJ or MSFT were considered growth stocks at the expense of boring industries like commodities and manufacturing. In that respect, the current frenzy has changed something; made the growth stocks of old into value stocks of today.

JNJ manufactures and sells a variety of health care products worldwide. The Consumer segment produces personal care and hygiene products for oral and baby care, first aid use, non-prescription drug usage, sanitary protection and skin and hair care. Some of the Company's major brands are Band-Aid bandages, Carefree feminine hygiene products, Johnson's baby care products, Mylanta acid controller, Neutrogena skin and hair care products and Tylenol pain and cold symptom relievers. The Pharmaceutical segment produces prescription drugs for allergy, antibacterial, anti-fungal, anti-anemia, contraceptive, dermatological, gastrointestinal and pain management uses. These drugs include Ergamosil, a colon cancer drug, Floxin antibacterial, Imodium, an anti-diarrhea product, Leustatin, for leukemia, and Retin-A dermatological cream for acne. The Professional segment manufactures products such as surgical and medical equipment and devices for use in the professional health field.

JNJ kept pace with the stock market, in fact outperformed most drug stocks, until the end of November. Then an analyst downgraded the entire pharmaceutical sector due to its political concerns. The analyst feared that during the next year the political environment will create volatility in drug stocks because healthcare will be a large topic in the run for the presidency. The stock promptly gave up more than half of its gain for the year. In following weeks, things got worse. One of Johnson & Johnson's overseas partners, Raisio of Finland, reported that its anti-cholesterol food agent, Benecol, isn't selling as well as hoped for in the good old United States of America. And of course, the feverish pitch to buy only the Internet stocks at the expense of all others took hold.

JNJ is not staying out of the Internet but it is a user rather than a creator in that space. Overall, the Internet is being used to speed the regulatory approval process. It is also improving research, development, training and recruitment as well as the distribution of goods and manufacturing and informing patients. Johnson & Johnson is eyeing a 30- to 40-percent decrease in inventory backlog because of the quicker distribution and manufacturing provided by the Web.

In the third quarter, sales at the J&J rose 17.9% year-over-year to $6.7 billion, while net income rose 14.4% to $1.1 billion and earnings per share (EPS) gained 14.3% to $0.80. All of J&J's business lines showed strength in almost all geographic areas. Domestic sales rose 24.1% from last year, while international sales gained 10.7%. Following a 25.4% year-over-year jump in the second quarter that was partially attributed to early pharmaceutical buy-ins, third-quarter worldwide pharmaceutical sales gained an impressive 23.9% to $2.6 billion, with heady 35.7% growth in domestic revenue. Best-selling drugs continue to include Procrit (anemia), Duragesic (pain), Risperdal (antipsychotic), and Levaquin (anti-infective). On deck to help sales grow and expand J&J's drug pipeline is the recent $4.9 billion acquisition of biotech Centocor, alongside new FDA approval for Aciphex and FDA approval of additional uses for Topamax, both of which were received in the third quarter.

Following an especially stagnant 1998, J&J's professional products division has cleared a path of impressive growth this year as well. Part of it is fueled by last year's DePuy acquisition, which should add to EPS next year and is adding to sales right now. Going against the recent trend, international sales growth in this division topped domestic growth, up 20.8% compared to a 19.2% gain domestically. During the quarter, J&J received government approval to sell its new CrossFlex coronary stent.

Currently 8 analysts rate JNJ strong buy, 16 moderate buy and 6 hold. Forecast EPS for the year ending December 99, ranges from $3 to $3.15 and short term volatility on or around January 24, the stock will react to whether the numbers are higher or lower than the average of $3.08. The company has a Market Capitalization of $130.3B and trades at a Price/Book ratio of 8.19 and a Price/Sales of 4.83.

Charts:

The full value P/E ratio for Johnson and Johnson is 32 times its earnings, not multiples of hundred. In times past, this was considered a growth multiple and it still is if you are looking beyond the immediate.

Translating the P/E multiple based on this year's expected EPS of $3.08, the stock is currently trading at about a 10% discount to fair value. IF you look at next year's numbers (EPS forecast of $3.38), the stock could easily return 20% as soon as the clouds over drug stocks dissipate.

Return on Equity  24.10%
Debt/Equity 22%
Plowback ratio 65%
Beta 0.94

Last Updated June 10, 2000