In my opinion, with the recent run up in stock prices during the month of September, the stock market is slightly overvalued. Therefore, investing fresh capital in defensive stocks would be the smart thing to do. In the next few articles, I plan on performing valuation analysis for solid dividend paying companies from various sectors and adding the most attractive names to my personal portfolio.
In this article, I will attempt to determine the fair value of Johnson & Johnson (JNJ).
Company Financials and Valuation
Johnson & Johnson is a global health care giant operating through over 250 companies across the globe with revenues in excess of $60 Billion. The company dominates most of its business segments (70% of the revenues come from segments where JNJ occupies either number 1 or 2 position), and sells everything from Band-Aid to Tylenol. JNJ has a long history of paying increasing dividends to its shareholders. The stock currently yields 3.5%.
Company Fundamentals/Earnings
Market Cap = $173 Billion
Sales (TTM) = $62.6 Billion
Income (TTM) = $13.5 Billion
Net Profit Margin = 21.6%
Return on Equity (TTM) = 27%
Return on Equity (Last 5 Yrs) = 25%
Return on Assets (TTM) = 15%
Return on Equity (Last 5 Yrs) = 16%
Current Ratio = 2.27
TTM EPS = $4.84
Average Analyst 2010 EPS Estimate = $4.71
Average Analyst 2011 EPS Estimate = $5.03
Discounted Cash Flow Valuation
DCF valuation of JNJ was performed by employing a two-stage model with a high growth period of 10 years. It should be noted that JNJ invests heavily in R&D ($7 Billion last year). Therefore R&D expenses were capitalized as part of this analysis. The major inputs and the valuation results are presented below.
JNJ | |
High Growth Period | |
Bottom-Up Beta for High Growth | 1.13 |
Equity Risk Premium | 6.5% |
Cost of Capital (Years 1 to 5) | 9.62% |
Average Cost of Capital (Years 6 to 10) | 8.75% |
Growth Rate (Years 1-5) | 6% |
Average Growth Rate (Years 6-10) | 3.6% |
Stable Growth Period | |
Bottom-Up Beta for Stable Growth | 1.0 |
Equity Risk Premium | 6.5% |
Cost of Capital | 8.18% |
Growth Rate | 2.0% |
Valuation | |
Present Value of FCFF in High Growth Period (Billions) | $90.5 |
Present Value of Terminal Value of Firm (Billions) | $87.6 |
Cash and Marketable Assets (Billions) | $18.9 |
Total Firm Value (Billions) | $197.0 |
Outstanding Debt | $11.6 |
Market Value of Equity | $185.4 |
Market Value of Equity/Share | $66.2 |
Relative Valuation
The estimated fair value using various relative valuation methods is presented below. The current multiples shown below are based on 2010 EPS estimate of $4.71. It should be noted that the historical data was relied upon to develop the estimates shown below. Adjustments were made to account for outliers present in the dataset.
JNJ | |||
Current | Estimate | Fair Value | |
P/E | 13.33 | 13.94 | $66 |
P/S | 2.82 | 2.80 | $62 |
(P/E) / (P/E – Peers) | 1.00 | 1.10 | $69 |
(P/E) / (P/E – S&P 500) | 0.71 | 0.79 | $70 |
Average | $66.8 | ||
Fair Value
The results from my DCF analysis and relative valuation both indicate a fair value of approximately $66.5 a share for JNJ. Accordingly, JNJ is currently trading at a discount of approximately 6%. My price target of $70 by December 2011 is obtained by applying a P/E of 13.94 to 2011 average analyst EPS estimate of $5.03. Adjusting for dividends, this implies a 15% return on investment.
(Kindly use this article for information purposes only. Please consult your investment advisor before making any investment decision)
Disclosure: None
