Chapter two of A Fistful Of Valuations In The Style Of Warren Buffett & Charlie Munger by Bud Labitan
A Fistful Of Valuations – Chapter 2
An estimated valuation of Johnson & Johnson, JNJ was first performed on 5/6/2010.
Johnson & Johnson is engaged in the research and development, manufacture and sale of a range of products in the health care field. The Company operates in three business segments: Consumer, Pharmaceutical, and Medical Devices and Diagnostics. In July 2009, Johnson & Johnson completed the acquisition of Cougar Biotechnology, Inc. with approximately 95.9% interest in Cougar Biotechnology's outstanding common stock. In September 2009, Elan Corporation, plc and Johnson & Johnson announced that JANSSEN Alzheimer Immunotherapy, a newly formed subsidiary of Johnson & Johnson, has completed the acquisition of substantially all of the assets and rights of Elan related to its Alzheimer`s Immunotherapy Program (AIP).
Last Price 63.40 52 Week High 66.20 52 Week Low 53.54 Does JNJ make for an intelligent investment or intelligent speculation in 2010? The 2015 discussion starts at the end of this chapter.
Let’s do a rough estimation of intrinsic value per share for 2010. Starting with a base estimate of annual Free Cash Flow at a value of approximately $14,000,000,000 and the number of shares outstanding at 2,758,000,000 shares (In 2015, the current number of shares outstanding is2,770,000,000.); I used an assumed FCF annual growth of 8 percent for the first 10 years and assume zero growth from years 11 to 15. Review the Free Cash Flow record here, and think about its sustainability:
Starting with an assumed FCF annual growth of 8 percent, the estimated intrinsic value per share is approximately $ 80.6 and you entered at a market price of $63.4 , so the P/V ratio = .79 and the estimated bargain = 21 percent. This revealed a purchase price bargain of 21 percent, and a relative FCF growth of 8 percent. So, the estimated effective annual yield may be greater than 10.4 % if held for ten years. The resulting estimated intrinsic value per share (discounted back to the present) is approximately $80.6.
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Market Price = $63.4 Intrinsic Value = $80.6 (estimated) Keep in mind, and compare that Coca Cola’s Debt/Equity ratio (2010 figures) is .47 or 47 percent; the Debt/Equity ratio here = 0. The resulting Price To Value (P/V) ratio = .79 and the estimated bargain = 21 percent.
More importantly, before we make a purchase decision, we must decide ( filter #1 ) if JNJ is a high quality business with good economics. Does JNJ have ( filter #2 ) enduring competitive advantages, and does JNJ have ( filter #3 ) honest and able management. The current price/earnings ratio = 13.7 Its current return on capital = 17.91
Using a debt to equity ratio of near zero, JNJ shows a 5-year average return on equity = 27.8
The biggest threat to profitability is: Competition and pricing.
The main competitors are: Abbott Laboratories, Amgen Inc., AstraZeneca PLC, Biogen Idec Inc., Bristol-Myers Squibb Company, Genentech, Inc., Genzyme Corp., Gilead Sciences Inc., GlaxoSmithKline plc, Johnson & Johnson, King Pharmaceuticals Inc., Life Technologies Corporation, MedImmune, L.L.C., Merck Serono S.A., Mylan, Inc., Novartis AG, Pfizer Inc., Ranbaxy Laboratories Limited, Sandoz International GmbH, Sanofi-Aventis, Teva Pharmaceutical Industries Limited, and Watson Pharmaceuticals Inc.
The Main Competitive Advantage is: Johnson & Johnson is the world's second largest and most broadly based manufacturer of health care products. The company holds a significant share of the consumer and pharmaceutical markets. JNJ is also the world's largest developer and manufacturer of medical treatment and diagnostic devices. The consumer health market is expanding as consumers are taking greater responsibility and interest in their own health. Johnson & Johnson owns highly successful brands such as Tylenol, Band-Aid, and Neutrogena. The acquisition of Pfizer's Consumer Healthcare division in 2006 and addition of brands such as Listerine, Lubriderm, Visine, and Neosporin further solidified Johnson & Johnson dominance in consumer health care. Further discussions on competitive pressures can be viewed here:
You the reader can insert your notes about management here:
Some industries have higher ROE because they require no assets, such as consulting firms. Other industries require large infrastructure builds before they generate a penny of profit, such as oil refiners. Generally, capital-intensive businesses have higher barriers to entry, which limit competition. But, high-ROE firms with small asset bases have lower barriers to entry. Thus, such firms face more business risk because competitors can replicate their success without having to obtain much outside funding.
Growth benefits investors only when the business can invest at incremental returns that are enticing; only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor. The wonderful companies sustain a competitive advantage, produce free cash flow, and use debt wisely.
Does JNJ make for an intelligent investment or speculation? Time is said to be the friend of the wonderful company and the enemy of the mediocre one. Before making an investment decision, seek understanding about the company, its products, and its sustainable competitive advantages over competitors. Next, look for able and trustworthy managers who are focused more on value than just growth. Finally ask: Is there a bargain relative to its intrinsic value per share today?
Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that causethe stock to be misappraised. In terms of Opportunity Cost, is JNJ the best place to invest our money today? Or, are there better alternatives? How will JNJ compete going forward? Technologies change and new technology can emerge. Keep in mind that a financial report like this is a reflection of the past and present. It may be used to project a future, but it may not account for factors yet unseen. Therefore, pay attention to competitive and market factors that may affect changes in profitability.
McNeil Consumer Healthcare, the JNJ subsidiary that makes Tylenol products, posted seven recall notices between September 2009 and March 2010. The company voluntary recalled 43 over-the-counter medicines, including liquid versions of Tylenol, Motrin, Zyrtec and Benadryl, because of "manufacturing deficiencies which may affect quality, purity or potency," according to the FDA. Those "manufacturing deficiencies" included manufacturing process, control, and procedure issues, such as inadequate laboratory facilities and untrained staff.
See the full article from DailyFinance:
In summary, using a debt to equity ratio of near zero, JNJ shows a 5-year average return on equity = 27.8. Based on a holding and compounding period of 10 years, and a purchase price bargain of 21.3 percent, and a relative FCF growth of 8 percent, then the estimated effective annual yield on this investment may be greater than 10.4%.
Going forward, are there any transformational catalysts or condition indicators imaginable on the horizon? Technologies change and new technologies will appear on the scene. Would brand loyalty keep customers buying here?
SEC Filings online: http://www.sec.gov/cgi-bin/browseedgar?company=&CIK=JNJ&filenum=&State=&SIC=&owner=include&action=getcompany
Now, let’s discuss Johnson & Johnson, JNJ, results over the past five year period. As a business, the Net Profit Margin of Johnson & Johnson was in the range of 21.65 in 2010. In 2015, the Net Profit Margin is 22.41 TTM. This indicates that Johnson & Johnson has competitive advantages. And, compared to the previous business, JNJ has higher profit margins for its product/service mix.
The Return On Equity of Johnson & Johnson was in the range of 24.88% in 2010. In 2015, the Return On Equity is 21.59. This indicates that Johnson & Johnson is producing nice returns for its shareholders.
In its latest annual report of 2014, management states that research activities represent a significant part of the Company’s businesses.
Research and development expenditures relate to the processes of discovering, testing and developing new products, improving existing products, as well as demonstrating product efficacy and regulatory compliance prior to launch.
Worldwide costs of research and development activities amounted to $8.5 billion, $8.2 billion and $7.7 billion for fiscal years 2014, 2013 and 2012, respectively. Major research facilities are located not only in the United States, but also in Belgium, Brazil, Canada, China, France, Germany, India, Israel, Japan, the Netherlands, Singapore, Switzerland and the United Kingdom.
From this case, I have learned to appreciate JNJ’s strong brands and research efforts to generate new products. So, is Johnson & Johnson a business that I would invest in today? As of October 20th, 2015, Valuepro.net estimates the intrinsic value per share of JNJ at:$127 The market price is at: $97.71
Therefore, Johnson & Johnson appears to be a high quality bargain at this time.