Johnson & Johnson (NYSE:JNJ) stock has bounced back. Shares faced significant selling pressure last year amid mounting legal worries. But investors have returned to a long-term focus — and JNJ stock reached an all-time high on Wednesday before pulling back over the last two sessions.
Even with JNJ stock up 18% from a 52-week low reached in October, there still should be more upside ahead. Valuation is reasonable and the dividend is solid.
Perhaps most importantly, J&J’s defensive business model offers protection against market volatility. Right now, that seems like an awfully attractive quality.
Legal Issues Fade
Two discrete legal issues have weighed on JNJ stock over the past couple of years. Long-running claims that the company’s talcum powder contained asbestos have driven multiple lawsuits, including a $4.7 billion verdict in July 2018. Those claims were buttressed by a report from Reuters in December of that year which alleged that J&J may have known for years about asbestos-related liabilities.
The second issue relates to the company’s opioid business. Last year, a judge in Oklahoma awarded that state $572 million in damages (that sum was later reduced by $107 million). The company has settled a similar suit in Ohio for $20 million, while facing other trials in states like Washington and New York.
There’s no doubt these issues have weighed on JNJ stock. In fact, shares fell 10% in a single session after the Reuters report was released, wiping out over $35 billion in market value. Opioid-related risks have pressured other stocks like Mallinckrodt (NYSE:MNK) and Teva Pharmaceutical (NASDAQ:TEVA). But the company’s release of tests showing zero asbestos contamination in late October sent the stock higher, and offset the effect of a sell-off following Q3 earnings that month.
And so it appears the legal issues have faded. It’s possible they will re-emerge; certainly few if any investors anticipated the seismic impact of the Reuters report. At least for now, however, investor focus has returned to the long-term case.
The Case for JNJ Stock
And that case remains attractive. JNJ stock remains reasonably valued, at 16.5x the midpoint of the company’s guidance for earnings per share this year. That’s a below-market multiple for a company expecting solid growth.
Admittedly, guidance only suggests 3.1%-4.8% growth in EPS year-over-year. But lower “other income” is having an impact, as is foreign currency translation. J&J, according to its investor presentation, expects core operating profit growth of 7.5% at the midpoint of its range.
That growth is being driven by strength across J&J’s business. In pharmaceuticals, still the most profitable segment, J&J is growing at an above-market rate, thanks to drugs like cancer treatment Darzalex and Stelara. Medical device growth has accelerated nicely in recent years and more improvement is expected this year. And the company’s consumer business, backed by well-known brands like Tylenol and Sudafed, remains healthy.
It’s not the sexiest business, to be sure. And, even including dividends, JNJ stock has underperformed the S&P 500 over 1-, 3-, 5-, and 10-year periods. But that underperformance isn’t surprising: stable but lower-growth stocks like JNJ should lag in a bull market.
The trade-off is that a defensive stock like JNJ offers some protection in a declining and/or more volatile market. With U.S. stocks being buffeted by coronavirus fears, that protection seems awfully valuable at the moment.
So what goes wrong here? Even beyond legal concerns, there are risks.
One is a broader market downturn. It’s tempting to assume that since J&J has little macroeconomic exposure, its stock should be relatively immune to market swings. But history shows that’s not necessarily the case. For instance, shares lost over one-third of their value from 2008 highs to March 2009 lows. Indeed, JNJ stock slipped in each of the last two sessions despite hopes the company can develop a coronavirus vaccine.
There are company-specific risks as well. As is the case with many pharmaceutical stocks, patent expiration can pressure earnings. Revenue from Remicade and Zytiga both saw double-digit declines on a percentage basis in the fourth quarter. Baby care product sales are falling sharply. Bausch Health (NYSE:BHC) and Alcon (NYSE:ALC) are providing stiffer competition for market share in the profitable vision care business.
It’s unlikely that JNJ stock necessarily plunges at this point. But investors do have other options in pharmaceuticals — and with that segment driving over 60% of profit, JNJ is mostly a pharmaceutical play. Merck (NYSE:MRK) still looks attractive thanks to cancer drugs like blockbuster Keytruda. Pfizer (NYSE:PFE) has its challenges, but the stock is cheaper on an earnings basis and its 4.08% yield easily tops JNJ’s 2.55%.
All that said, I’d rather own JNJ than either of those names. The diversified business, defensive potential, and dividend make Johnson & Johnson stock particularly attractive for investors with a conservative bent. JNJ offers greater income than a 10-year Treasury, and while downside isn’t zero, there’s some protection. In this suddenly volatile market, that’s a nice combination — and one that makes JNJ at least worth a very long look.
As of this writing, Vince Martin has no positions in any securities mentioned.