A lot of investors and analysts considering Johnson & Johnson (JNJ) are focused primarily on qualitative speculation about the company’s prospects. For example, Seeking Alpha contributor Eli Inkrot looks primarily at dividend growth prospects for the company while Alexander Poulos views the company’s exposure to the healthcare sector as an investment opportunity. However, it is critical when analyzing Akamai to consider the company’s intrinsic value in relation to its price.
In fact, Benjamin Graham, the father of value investing, taught that the most important aspect to consider is whether a company is trading at a discount relative to its intrinsic value. It is through a thorough fundamental analysis that the investor is able to make a determination about a potential investment’s merits. Here’s a look at how the company fares in the ModernGraham valuation model.
The model is inspired by the teachings of Benjamin Graham and considers numerous metrics intended to help the investor reduce risk levels. The first part of the analysis is to determine whether the company is suitable for the very conservative Defensive Investor or the less conservative Enterprising Investor who is willing to spend a greater amount of time conducting further research.
In addition, Graham strongly suggested that investors avoid speculation in order to remove the subjective elements of emotion. This is best achieved by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another. By using the ModernGraham method, one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries.
JNJ data by YCharts
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Defensive Investor – Must pass at least 6 of the following 7 tests: Score = 6/7
- Adequate Size of Enterprise – Market capitalization of at least $2 billion – PASS
- Sufficiently Strong Financial Condition – Current ratio greater than 2 – PASS
- Earnings Stability – Positive earnings per share for at least 10 straight years – PASS
- Dividend Record – Has paid a dividend for at least 10 straight years – PASS
- Earnings Growth – Earnings per share has increased by at least 1/3 over the last 10 years, using 3-year averages at the beginning and end of the period – PASS
- Moderate PEmg (price over normalized earnings) Ratio – PEmg is less than 20 – PASS
- Moderate Price-to-Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – FAIL
Enterprising Investor – Must pass at least 4 of the following 5 tests or be suitable for a Defensive Investor: Score = 5/5
- Sufficiently Strong Financial Condition, Part 1 – Current ratio greater than 1.5 – PASS
- Sufficiently Strong Financial Condition, Part 2 – Debt-to-Net Current Assets ratio less than 1.1 – PASS
- Earnings Stability – Positive earnings per share for at least 5 years – PASS
- Dividend Record – Currently pays a dividend – PASS
- Earnings Growth – EPSmg greater than that 5 years ago – PASS
|Value Based on 3% Growth||$76.21|
|Value Based on 0% Growth||$44.68|
|Market Implied Growth Rate||5.27%|
Balance Sheet – March 2015
Earnings Per Share
Earnings Per Share – ModernGraham
JNJ Dividend data by YCharts
Johnson & Johnson passes the initial requirements of both the Enterprising Investor and the more conservative Defensive Investor. The Defensive Investor’s only initial concern is the high PB ratio while the Enterprising Investor has no initial concerns. As a result, all value investors should feel very comfortable proceeding to the next part of the analysis, which is a determination of the company’s intrinsic value.
When it comes to valuation, it is critical to consider the company’s earnings history. In this case, the company has seen its EPSmg (normalized earnings) rise from $4.17 in 2011 to an estimated $5.26 for 2015. This level of earnings growth does not support the market’s implied estimate for 5.27% annual growth over the next 7-10 years.
In fact, the recent earnings growth has averaged around 5.21% per year, but as a safety margin, the ModernGraham valuation model reduces the expected future growth rate slightly in order to account for the possibility in a downturn in the business. Thus, the model returns an estimate of intrinsic value falling below the market’s price, indicating that Johnson & Johnson is overvalued at the present time.
Disclaimer: The author did not hold a position in any company mentioned in this article at the time of publication and had no intention of changing that position within the next 72 hours. Logo taken from Wikipedia for the sole purpose of identifying the company; this article is not affiliated with the company in any manner.