Fundamental analysis of Johnson and Johnson's stock valuation

JOHNSON & JOHNSON

The Fundamental Analysis of Johnson & Johnson Inc.

(J& J, 2005)

Economic and Market Analysis

Globalization

Industry Analysis

Company Analysis

Brief History of the Company

Analysis of Capital Asset Pricing Model

Intrinsic Value

Valuation Measures

Trading Information

Competitors

Awards & Recognition

Our modern business world consists of an extremely competitive global economy where manufactures search for opportunities to strategically reduce costs and increase market share and profitability. Historically, the most often chosen solution for holding down costs was to systematically reduce labor and therefore eliminate the associated costs of labor. In the 1990's for example, many companies chose lay-offs, downsizing or to simply slow manufacturing processes and these types of scenarios consistently headed the 'business section' headlines. In reality, these methodologies were merely attempts to reduce overhead. Manufactures today are finding that labor is now at more of a premium level which entails that it can no longer be reduced without indirectly or directly affecting output capacity, quality and efficiency quotas because manufacturing lines are at a barebones minimum. All of these ideas affect a company's stock and the overall manufacturing process.

This report therefore is a stock analysis of Johnson & Johnson Inc. And their efforts at reducing costs, increasing market share, meeting their shareholders and stakeholders as well as industry expectations while still fulfilling the very high levels of quality demanded by their customers. Johnson & Johnson Inc. has made great strides in divesting itself of unprofitable functions and maintaining high levels of customer support for its many products and associations. Through new acquisitions, novel business strategies and a regular migration to cheaper labor pools, Johnson & Johnson Inc. has become a strong force to be reckoned with in the highly competitive major drugs and healthcare industry.

The Fundamental Analysis of Johnson & Johnson Inc.

Introduction

The report represents the research and methods used to create a fundamental analysis of Johnson & Johnson Inc. In other words, this report aims to provide insights into the company as well as being a financial analysis report. The report attempted to use a top-down approach for security analysis-content for Johnson & Johnson Inc. which entailed using between five to ten years of data analysis for the company. Basically, this project was nothing more than a detailed security analysis project designed to apply various techniques for evaluating the desirability of a company's common stock. "Johnson & Johnson, through its operating companies, is the world's most comprehensive and broadly-based manufacturer of health care products, as well as a provider of related services, for the consumer, pharmaceutical, and medical devices and diagnostics markets. The more than 200 Johnson & Johnson operating companies employ approximately 111,000 men and women in 57 countries and sell products throughout the world." (J& J, 2005)

A main objective was also to demonstrate familiarization with various tools and techniques that are pertinent in a security's valuation. This report encompassed typically available data to implement the various techniques of analysis and focused on Johnson & Johnson and resurgence in the highly competitive major drug, drug manufacturing and healthcare industries. Trends in these industries have forced companies such as Johnson & Johnson to completely reevaluate the way they will do business today and in the future. The healthcare industry has become an extremely mobile global business that continues to be driven by cheap labor and resources from new and emerging markets in various industrialized and developing countries. Johnson & Johnson has had to reinvent their business and marketing strategies in order to grow and prosper in the twenty-first century and beyond and this report will evaluate the industry, economic and market trends and the company itself to demonstrate whether or not they seem as though they will remain a viable investment opportunity for investors.

Globalization

A real trend in the healthcare industry has been the continued migrations of industry players into developed and newly emerging markets. The twenty-first century's new world order appears to have been founded on a single, global, technologically advanced, highly competitive economic market place. This single global market is also being serviced by fewer industrialized powers that are teaming together to form free trade agreement conglomerates or states. Consider the phenomenon be demonstrated by the likes of the oil producing nations forming OPEC. The United States, Canada and Mexico all agreed to open their markets to each other with the North American Free Trade Agreement or NAFTA. Of course, the majority of the world may believe that those combinations have created the world's largest combined Gross Domestic Products -- but, the European Union has effectively equaled the benefits of OPEC and NAFTA through their own combined economic and trade agreement pacts. The member countries include: Austria, Belgium, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Slovakia, Slovenia, Spain, Sweden, and the United Kingdom. Bulgaria and Romania are scheduled to join the union in 2007 and Croatia and Turkey are currently considered as candidate countries.

(Akademie de)

When we discuss the word globalization, we often assume it is a new phenomenon or that it is a race between the United States, China and the developed and emerging nations to see who can drain the world of its oil resources the fastest. "The global appetite for crude in 2003 will grow by a robust 1.9%, or 1.44 million barrels a day, and in 2004 by 1.5%, or 1.16 million barrels a day. The IEA raised its estimates for daily demand growth in the two years by 160,000 barrels and 90,000 barrels, respectively." (Stanley) But, oil and other natural resources are just a few reasons why the world has been gradually moving to a more global business environment.

Technology is another. By the standards of global trade in the realm of ancient Rome or Mesopotamia, our modern day ability to traverse large land masses is no longer limited by our technology. Today, airplanes, ocean transports, satellite communications, the Internet and even cell phones far surpass the abilities of our ancestors. For example, the current age of information and technological advances make it possible to move billions of dollars in milliseconds from anywhere in the world. All of this opens up new opportunities for trade and investment on a global spectrum.

With all of this being considered, Globalization entails interconnectivity of localities and those localities span more local sites such as the day-to-day social, economic, cultural, and political aspects of the communities being served. It implies more a physical expansion in the sense of geographical domain and increases in the scale or volume of global resources the potential of international conglomerates like Johnson & Johnson and gives them the potential to alter the lives of everyone on the entire planet.

Industry Analysis

The industry in is in the middle of a growing concern that healthcare related costs are going to eventually put health out of reach of the majority of the world. For example, as America's population continues to age, a large number of the senior citizens cannot afford the cost of their basic medicines. Many grandparents are in predicaments where the only solution has been to find cost relief across the United States' boarders in Canada or on the internet. Ironically, this idea has appealed to the major drug and healthcare industry players including Johnson & Johnson. The companies have all become obsessed with the notion of shaping their own fate in a highly technical global economy.

New marketing strategies incorporate the internet has addressed the new demand for personalized healthcare. Consumers have been experimenting with the notion of buying their pharmaceutical and healthcare related products directly from the manufacturing process and existing technology makes this concept very real. The idea works by a person logging on to a company's site like Johnson & Johnson which would list medical professionals such as local general practioners. When a person needs a prescription filled, he visits a doctor, logs on to the manufacture with a prescription code provided by the doctor and the manufacturer confirms this prescription code in real time via a three way internet communication with the physician's system and the medicine would be FedEx'd overnight directly to the consumer.

Although these scenarios are still forecast for the future, the healthcare industry especially major drugs consists of very capable organizations all participating in: Biotechnology & Drugs, Healthcare Facilities, Major Drugs an the Medical Equipment & Supplies. The industry is a highly competitive industry lead by major global powers as demonstrated by the industry leaders in total revenues:

PFIZER INC [PFE]

$53.1 B

JOHNSON AND JOHNS DC [JNJ]

$48.6 B

GLAXOSMITHKLINE PLC [GSK]

$37.9 B

BAYER AKTIENGES ADS [BAY]

$36.8 B

NOVARTIS AG ADS [NVS]

$29.0 B

ROCHE HLDG LTD SPONS [RHHBY.PK]

$25.6 B

MERCK CO INC [MRK]

$22.7 B

ASTRAZENECA PLC ADS [AZN]

$22.1 B

ABBOTT LABORATORIES [ABT]

$20.4 B

BRISTOL MYERS SQIBB [BMY]

$19.3 B

(Yahoo Finance Industry Center, 2005)

Other industry advances include the fact that the major drug and healthcare industry has systematically reduced its dependence on suppliers while at the same time pressuring them into improving the quality of the resources as well as implementing such innovations as just-in-time delivery for supply chain management. These requirements have escalated the communication process between suppliers and the industry both digitally and verbally. Computing technology for instance at Johnson & Johnson has directly connected them with their suppliers all over the world and therefore increases the overall manufacturing efficiency, quality and productivity. The strategy may be to continue to search for more economical and cheaper resources to be delivered in cost effective manners controlling both price and time.

Company Analysis

Johnson & Johnson Inc. is headquartered at One Johnson & Johnson Plaza, New Brunswick, NJ 08933. "The story of Johnson & Johnson is one of innovative products, strong leadership and an ongoing commitment to our customers, employees, communities and shareowners. Since 1886, when it was formed in a former wallpaper factory along the Raritan River in New Brunswick, New Jersey, the Company has remained focused on our founders' mission of creating safe and effective health care products." (J& J, 2005) The company considers itself as the world's largest, most comprehensive and broadly-based manufacturer of health care products and related services.

Johnson & Johnson as an organization focuses on the manufacture and sale of products related to human healthcare and individual well-being and conducts business all over the globe through its more than two hundred operating companies stationed throughout the world. "The Company's business is divided into three segments: Consumer, Pharmaceutical and Medical Devices and Diagnostics. The Consumer segment manufactures and markets a range of products used in the baby and child care, skin care, oral and wound care and women's healthcare fields, as well as nutritional and over-the-counter pharmaceutical products. The Pharmaceutical segment's principal worldwide franchises are in the antifungal, anti-infective, cardiovascular, contraceptive, dermatology, gastrointestinal, hematology, immunology, neurology, oncology, pain management, psychotropic and urology fields. The Medical Devices and Diagnostics segment includes a range of products used by or under the direction of physicians, nurses, therapists, hospitals, diagnostic laboratories and clinics." (Yahoo Finance, 2005)

(Yahoo Finance, 2005)

The organization has seen the future and has therefore begun to move in the right direction by expanding its global manufacturing capabilities and reach. The company has expanded by adding new manufacturing facilities throughout the alphabet as they have companies in Algeria through Zimbabwe. They have made the necessary internal changes to offer unique opportunities for attracting new vendors and suppliers that have instituted the just-in-time delivery methodology and they have increased their research and development outreach in all corners of the world.

Because of the highly competitive nature of its industry, Johnson & Johnson have implemented many efficiency strategies such as the Six Sigma and Total Quality Management control processes as well as many other cost cutting processes and strategic approaches. The company demonstrates a sound business approach with: strong leadership, strong market share in its industries, strong financial stability, relatively few employment issues, a sound company's ethics and global green policy and strong customer support for their products and services.

Brief History of the Company

The company has a long history of innovation and success. The founders created the first 'ready-made, ready-to-use surgical dressings' and initiated the way for 'application of the theory of antiseptic wound treatment' in the mid-1880's. These new products and services concepts literally reduced the threat of infection and disease in postoperative victims and helped save many lives in the early days of modern medicine. "The story begins with the discoveries of Sir Joseph Lister, a noted English surgeon, who identified airborne germs as a source of infection in the operating room. He called them, with grim aptness, the "invisible assassins." Medical science was beginning to understand, however imperfectly, the need for greater care in protecting the wound area. Yet, this concept of myriad living organisms, unseen and deadly, remained beyond the grasp of many surgeons in the 19th century who were doubtful or even contemptuous of Lister's work." (J& J, 2005) By 1890, the company added many new products and services such as including 'treating cotton and gauze dressings' which eventually lead to an even more sterile antiseptic product which also lead to the creation of a bacteriological laboratory one year later.

After the company's first president, Robert Wood Johnson, died in 1910, the company management was on a mission to continuously create new products and services that would accommodate the medical community. From the demand produced by two world wars, Johnson & Johnson saw an amazing amount of international growth through today. "International growth, initiated in 1919 with the establishment of an affiliate in Canada, began in earnest in 1923 with an around-the-world trip by the two sons of Robert Wood Johnson. The young men, Robert Wood Johnson, who carried his father's name, and J. Seward Johnson, returned from their worldwide tour with the conviction that the Company must establish a strong international position. The following year, in 1924, Johnson & Johnson created its first overseas affiliate, Johnson & Johnson Ltd., in Great Britain. Over time, international affiliates of Johnson & Johnson were created in more than 50 countries. For example, companies were begun in Australia in 1931, Sweden in 1956, Japan in 1961, Greece in 1973, Korea in 1981 and Egypt in 1985." (J& J, 2005)

(CBS Market Watch, 2005)

Of course, just like any business history, the company has not simply had all clear sailing. "In 1982 and again in 1986 TYLENOL®, a product of our McNeil Consumer & Specialty Pharmaceuticals subsidiary, was altered by unknown individuals who placed deadly cyanide in the capsule form of the product. The result was the death of seven people in 1982. The product was voluntarily recalled and Johnson & Johnson took a $100 million charge against earnings. No one was ever convicted of the tampering and subsequent deaths. In 1986, as a result of the second tampering incident and another fatality, the decision was made to discontinue the sale of TYLENOL in capsule form, and subsequently the caplet form of TYLENOL was introduced. Johnson & Johnson received much praise for its quick and honest handling of the crisis." (J& J, 2005)

Through adversity, however, the company actually became stronger and better prepared to deal with risk and adverse situations. For example, after the second Tylenol problem, Johnson & Johnson reintroduced TYLENOL in completely innovative tamper-evident packaging which eventually helped them regain the market lead in over the counter pain medicine.

Analysis of Capital Asset Pricing Model

The Capital Asset Pricing Model or CAPM carries a time value of money to a higher level. In other words, the Capital Asset Pricing Model takes into consideration the inherent risk that is associated with any investment and the rates of return. The model allows investors to compare factors to a source such as the overall stock market or an individual index within the stock market. Investors attempt to reduce or minimize the risk factors. The Capital Asset Pricing Model therefore serves as a tool that will assist the investor in avoiding risk and when certain risk factor are involved, investors are rewarded for the additional risk.

Ks = Krf + B x (Km -- Krf) where

Ks = The Rate of Return

Krf = The Risk Free Rate

B = Beta

Km = The expected return on the overall stock market

For The Johnson & Johnson we can assume a risk free rate of five percent and an overall stock market return of ten percent with a Beta as of 5/10/2005 of 0.213.

Ks = Krf + B x (Km -- Krf)

0.06065 or 6.07% = 5% + 0.213x (10% - 5%)

The CAPM says that Johnson & Johnson's return on investment must be greater than a return of 6.07%. And the range of growth last year was around 18.20% growth. Thus, an investment in the Johnson & Johnson of $1,000 over the course of the next three years would provide a rate of return of:

First Year Return = $1,000 x (0.182 + 1) = $1,182

Second Year Return = $1,182 x (0.182 + 1) = $1,397.124

Third Year Return = $1,397.124 x (0.182 + 1) = $1,651.400568

Intrinsic Value

The company's potential can be seen by utilizing the CAPM method, but by demonstrating the intrinsic value of the Johnson & Johnson stock we can also see how these values change for both optimistic and pessimistic economic conditions as they relate to growth rates.

Current

Initial

Final

Discount

Intrinsic

Cash

Growth Rate

Growth Rate

Rate

Value

$1.00

10%

4%

11%

$23.09

$1.00

11%

5%

10%

$33.50

$1.00

12%

6%

9%

$58.00

If we were to assume that Johnson & Johnson spends ten years in a stage of growth during which cash per share or the free cash flow that it generates grows by the rate of the table bellows second column. Thus, during this period cash could be assumed to grow at the rate described in the column three. However, eventually everything would be discounted back into present time as demonstrated in the column four. Even minute economic changes could affect the rate of return for Johnson & Johnson from $23 to $58.

Recommendation and Conclusion

This report has been a stock analysis of Johnson & Johnson Inc. And their quest to find ways to reduce costs, increase market share, meet shareholder expectations and fulfill the quality demands by their customer base. From the investor perspective, Johnson & Johnson is a good middle of the road choice. They are heavily influenced by current economic factors in the United States including the healthcare and social security concerns and economic issues but they have a strong potential outlook because of the fact that as the baby boomers continue to age, the overall industry outlook will rise. The return on investment does not compete with some of the highly profitable tech stocks as well as other emerging industries such as BioTechs. However, Johnson & Johnson will beat a large portion of its own industry and others such as the auto industry. Johnson & Johnson has consistently been a force in medicinal and healthcare manufacturing, their stock has been providing a sound return on investment but there may be some hard researched better options.

If I was to purchase the Johnson & Johnson stock I would wait until the purchase price dipped below $60.00 (currently hovering around $66) during a market downturn with the intention of taking advantage of the high annual growth rates and therefore profiting on a long-term hold. The economy seems to be slowing but the international opportunities for the long run seem promising. Johnson & Johnson as an organization will continue to take advantage of the emerging markets and the new investments in factory and infrastructure in those markets will reap benefits over the long-term and could increase the growth rate dramatically and thus bring back a higher return on investment. "For the three months ended 4/3/05, revenues rose 11% to $12.83 billion. Net income rose 17% to $2.93 billion. Revenues reflect a positive impact of currency fluctuations and strong sales performance in major franchises. Net income reflects favorable product mix and cost improvement initiatives." (Yahoo Finance, 2005)