Firm Evaluation Johnson & Johnson

Firm Evaluation Johnson & Johnson (NYSE: JNJ) produces and markets a broad range of consumer products, pharmaceuticals and diagnostics in over one hundred countries around the world. They market under hundreds of brand names, such as Neutrogena, Band Aid, Listerine, Johnson & Johnson, Tylenol, DePuy, Cordis and a wide range of patented drugs trademarks. They do not control their retail channels but rather wholesale their items. JNJ engages in research and development related to the pharmaceutical and diagnostic fields.

The average growth rate for JNJ for the past couple of years is 10.47%. Therefore the expected revenues for JNJ this next year is last year's revenues times the expected growth rate: $61, 095 * 110.47 = $67,493 million. The expected average growth rate is based on the historic growth rate for the firm. JNJ's past two years consisted of one good year and one mediocre year. This provides a reasonable baseline for determining the growth rate that can be expected this year.

The company operates in segments that are relatively non-cyclical (health care), so internal factors are as significant as external ones. The economic slowdown can be expected to impact the business somewhat, but the company's returns in relation to market returns indicate a strong degree of independence from market performance. There company is on a strong growth trajectory. In lieu of evidence to support a different conclusion, the most reasonable thing is to assume that present growth trends will continue. The average inventory for JNJ in the past two years was $4,999.5.

The revenues were $61,095 last year. This gives us an inventory turn of 12.22 times. The average receivables in the past two years were $9,078 and the revenues were $61,095. This gives us a receivables turn of 6.73. There is no reason to assume that these ratios will change significantly. JNJ operates a diversified global conglomerate, which reduces the degree to which they are subject to economic shocks. There is no compelling evidence to suggest that these turnover ratios are going to change.

In fact, it is normally considered that without sound information regarding the firms operations, or guidance from the firm itself, even the analysts are not in possession of sufficient information to make such a determination. Therefore, in lieu of compelling evidence that would support a prediction, the only reasonable course of action is to utilize the current turnover ratios, understanding that there are some limitations to their value. Therefore, the forecast for next year's accounts receivable is equal to the receivables turn multiplied by the revenue growth rate.

This gives us $10,028 million. The forecast for next year's inventory is the inventory turn multiplied by the revenue growth rate. This gives us $5,523 million. Johnson & Johnson is a firm that does not need to increase its debt. The company generates ample cash flow without the need for external financing. They are a firm that generates ample cash and must decide how to use the money. Evidence of this can be found in the Statement of Cash Flows. JNJ's flows over the past three years have been $16,055, $4,083 and $7,770 million respectively.

Operating cash flows are higher still. JNJ has clearly demonstrated the ability to generate cash flow internally. In addition, JNJ has more debt than many of its peers. While JNJ is liquid, their liquidity ratios are inferior to the industry average. Their debt-to-equity ratio is higher than the average ratio of their peers as well. This indicates that for the industry, JNJ already holds a sufficiently high debt level.

They could in theory handle more, but it would be unwise for them to issue more debt if they have other options. For JNJ, the use of cash flow from operations is a much better option. They have been able to generate cash flow consistently from operations, and in the past few years have used this to pay down some of their debt. The NASDAQ site puts analyst earnings calls at $4.53 for 2008 and $4.67 for 2009. At a 12% discount rate, the present value of these are $4.044 and $3.7208 respectively.

To calculate using the residual income valuation approach we then add these to the book value of the equity today. The book value per share is the book value of the equity divided by the number of shares outstanding. According to the 2007 annual report number of shares outstanding is 3120 million. There have been more shares issued, but the outstanding at the end of the 2007 fiscal year is clearly indicated in the report.

The book value of the equity is $43,319 million, including share value and retained earnings so the book value per share is $13.88. When added to the present value of the future earnings this gives.