Slow and Steady Pays Off

 | Jul 09, 2013 | 4:00 PM EDT
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Many defensive, consumer-staple names have run way up over the last 18 months. Even with the pullback on higher rates, many now come with price-to-earnings ratios around 20. There has been one laggard, however, that is still trading well below its historical multiple: Johnson & Johnson (JNJ).

The diversified healthcare player straddles the medical and consumer staple categories. This could explain why shares trade at a discount, because analysts can't figure out which one it belongs to. But here's the catch: JNJ is not only trading at a discount to its peers but also to its historical valuation. Look at some comparables in both sectors.

Johnson and Johnson trades at a P/E of 16.6x but has averaged 19.9x over the past 15 years. That's a 16% discount. Merck (MRK) trades at 15.7x, which seems lower, but trades at an historic multiple of 17.5x, a discount of only 10.3%. Bristol-Myers (BMY) trades at 20.6x times with a historic multiple of 22.1x.

J&J's consumer-staple peers are even costlier. Procter & Gamble (PG) trades at 19.4x and an historical 19.5x. Colgate-Palmolive (CL) trades at 20.8x and 22.8x historically. Clorox (CLX) trades at 19.5x and 19.6x, historically. It's very difficult to find discounts within the consumer-staples space.

Companies trading at a discount often do so for a reason. But other than the "conglomerate discount," nothing else is holding J&J back. The business is humming along just as well as any of the above companies.

The first quarter was great. The pharma division led the way, growing sales by 10.4% year-on-year and winning FDA approval of its type 2 diabetes drug. Devices completed its acquisition of Synthes and grew revenue 10.2%. Consumer has finally reversed its concerning decline, now growing revenue by a healthy 2.2%. Overall revenue growth was 8.5%, and 2.8% without the Synthes acquisition.

This year, revenue is expected to grow between 4.5% and 6.7% with operating earnings at about the same pace. We should then expect JNJ to continue its 50-plus year streak and increase the dividend. Next year, it should increase by between 6% and 7%.

We also have the possibility of a breakup further down the road. A spinoff of the pharma division would be most likely. When asked by analysts last quarter, CEO Alex Gorsky said they were still looking into it. Personally, I question how gainful a breakup would be. JNJ has been a conglomerate for a long time, and its P/E ratio has averaged about 20 for the last 15 years. Could a breakup send prices above that ratio? I'm skeptical. A breakup certainly worked for Abbott Labs (ABT), though.

In the meantime, JNJ offers steady growth in both earnings and dividend income, not to mention a 3.1% yield. The stock could go up 15% before reaching its historical valuation. Slow and steady can really pay off. For the long-term investor who doesn't want to take on much risk, JNJ sticks out like a healthy thumb.

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