Johnson & Johnson: Reliable defensive blue chip stocks continue to deliver benefits

  • JNJ has made progress in reducing costs
  • Stocks are quite expensive relative to rolling and expected earnings
  • Wall Street consensus outlook is optimistic
  • The implied market outlook is bullish
  • Covered call writing looks attractive

Shares of Johnson & Johnson (NYSE:), the New Brunswick, New Jersey-based healthcare giant, rose 5% last Friday after learning that the company could, with its plans, resolve related lawsuits to talc products as well as a settlement on opioid lawsuits. .

As a result, the shares returned a total of 4.6% over the past 12 months, well below the 17.2% total return for the pharmaceutical industry as a whole.

While JNJ’s cumulative change over the past 12 months is modest, the stock has varied quite significantly, with a 12-month close at $179.47 on Aug 17, 2021 (9.7% above current price) , after closing at a YTD low of $153.07 on March 4, 2021 (5.9% below the current price), then closing at a second half low of $155.93 on November 30, 2021 ( 4.7% below the current price).

12 month JNJ price history.

Source: invest.com

However, the New Jersey-based healthcare giant still looks relatively expensive compared to rivals such as Pfizer (NYSE:) and Merck (NYSE:). JNJ’s 12-month P/E (TTM) of 21.25 is significantly higher than Pfizer’s 12.2 and Merck’s 15.7.

Comparing pharma companies on a rolling P/E basis ignores the potential for substantial variations in expected earnings, but JNJ also looks quite expensive using a forward P/E. Based on the consensus outlook for expected earnings, JNJ is 15.8compared to 6.8 and 10.4 for PFE and MRK, respectively.

Given JNJ’s relatively high valuation, it’s no surprise that the dividend yield, 2.55%, is also lower than the 3.35% at Pfizer or the 3.62% at Merck.

JNJ is a reliable dividend producer, with Dividend growth rate over 3, 5 and 10 years 5.6%, 5.8% and 6.4%, respectively. With the current history of growth in yields and dividends, the Gordon’s growth model gives an expected total return of 8.2%. This is very close to the 15-year annualized return of 8.19% per year and slightly below the 3- and 5-year annualized returns of 9.35% and 8.56% per year, respectively.

At April 12, 2021, I assigned a buy rating. While the expected upside potential was limited, the stock looked attractive on a risk-adjusted basis. With its low beta and volatility, and generally favorable outlook, JNJ seemed like a decent bet for a stable equity component of a portfolio – what I call portfolio ballast. Over the following months, JNJ reported a total of 4.04% over 6.4% for the (including dividends).

When reviewing JNJ, I looked at the fundamentals and two types of consensus outlook. The first is the well-known consensus rating from Wall Street analysts and the 12-month price target. The second, which may not be familiar, is the implied market outlookwhich represents the consensus among buyers and sellers of options on JNJ.

In short, the price of an option on a stock is largely determined by the market’s consensus estimate of the probability that the stock’s price will rise above (call option) or fall below (put option) a specific level (the strike price of the option) between now and when the option expires. By analyzing the prices of call and put options at a wide range of strike prices, it is possible to calculate a likely price prediction that reconciles option prices. These are the implied market outlook and represent the implied consensus outlook of the options market.

In April, JNJ shares looked somewhat expensive relative to earnings, but the consensus outlook from Wall Street analysts was upbeat and the consensus 12-month price target was about 15% above the stock price. at this moment. The implied market outlook through early 2022 was neutral, with low volatility. I gave an overall bullish rating, but indicated that a covered buy strategy is worth considering due to the high valuation.

With about 10.5 months since I analyzed JNJ, I updated the implied market outlook for JNJ and compared it with the current Wall Street consensus outlook.

Wall Street Consensus Outlook for Johnson & Johnson

E-Trade calculates the Wall Street consensus by combining the views of nine ranked analysts who have published ratings and price targets over the past 90 days. The consensus rating is bullish and the consensus price target is 15.2% higher than the current stock price. In April, the consensus rating was also bullish and the 12-month consensus price target was $191.21, or 18.6% above the stock price at that time.

JNJ: Wall Street analyst consensus rating, 12-month price target.

JNJ: Wall Street analyst consensus rating, 12-month price target.

Source: E-Commerce

invest.com calculates the Wall Street consensus outlook using the views of 17 analysts. The consensus rating is bullish and the consensus 12-month price target is 13.7% higher than the current stock price.

JNJ: Wall Street analyst consensus rating, 12-month price target.

JNJ: Wall Street analyst consensus rating, 12-month price target.

Source: invest.com

While the consensus outlook may vary by source, e-commerce and invest.com the estimates are very close to each other. The average of these two 12-month consensus price targets is 14.45%. Combined with the dividend yield of 2.55%, the consensus outlook for the expected total return is 17%.

Implied market outlook for Johnson & Johnson

I calculated the implied market outlook for JNJ for the 3.6 month period from now until June 17 and for the 10.7 month period from now until January 20, 2023 by analyzing the options that expire on those dates.

The standard presentation of the implied market outlook is a probability distribution of price return, with probability on the vertical axis and return on the horizontal.

Market-implied probabilities of return through June 17.
Market-implied probabilities of return through June 17.

Source: Author’s calculations based on E-Trade option quotes

The implied market outlook through June 17 shows two small spikes in probability corresponding to returns of +2.25% and -2.25%. This type of implied double-peak market outlook is not uncommon, but there is no practical significance in the details. The probabilities are skewed to favor positive returns, and the expected volatility calculated from this distribution is 22.1% (annualized). For comparison, the annualized volatility calculated from the implied market outlook in April 2021 was 19.8%.

To make it easier to directly compare the probabilities of positive and negative returns, I rotate the negative return side of the distribution around the vertical axis (see chart below).

Market implied price return probabilities through June 17.
Market implied price return probabilities through June 17.

Source: Author’s calculations based on E-Trade option quotes

This view shows how probabilities favor positive price returns. The probabilities of positive returns are significantly higher than the probabilities of negative returns of the same magnitude across a wide range of most likely outcomes (the solid blue line is above the dotted red line on the left three-quarters of the chart shown -above). This is a bullish outlook for JNJ.

The outlook through January 20, 2023 is slightly bullish with a less pronounced shift in odds to favor positive returns. The annualized volatility calculated from this outlook is 21.6%.

Market implied price return probabilities through January 20, 2023.
Market implied price return probabilities through January 20, 2023.

Source: Author’s calculations based on E-Trade option quotes

Both of these implied market outlooks indicated a bullish view through mid-2022 and a slightly bullish view through early 2023. Expected volatility looks stable at 21-22%. The implied market outlook was neutral in April 2021, but has now shifted to a bullish orientation.

As I write this, JNJ is trading at $164.53 and it is possible to sell a call from Jan 20, 2023 with a $165 strike for $11.25 (this is the bid price) . By buying JNJ at this price and selling the call option, the income from the option premium represents a return of 6.84% over the next 10.7 months.

During this period, JNJ should have three dividend payments of $1.06 each, for a total return from the covered call strategy of 8.8% (9.9% annualized total return). This is an attractive level of total income for a security with such low volatility.

Summary

JNJ is a mainstay of low beta defensive stocks. The stocks have had total returns of 9.4% and 8.6% over the past three and five-year periods. Gordon’s growth model indicates an expected return of 8.2%. In light of these numbers, the Wall Street consensus 12-month price target, with an expected total return of 17%, looks very bullish.

Typically, for a buy rating, I want to see a 12-month expected return that is at least half the expected volatility (which is around 22%). Wall Street’s consensus price target is well above this threshold. The implied market outlook for JNJ is also bullish.

I maintain my bullish rating on JNJ. Income-oriented investors, as well as those concerned about JNJ’s valuation, may consider writing covered call options on JNJ.

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