Comparing SSGs for Johnson and Johnson (JNJ)

Here are two bare-bones SSGs for Johnson and Johnson (JNJ) that I want to compare and a short discussion of some important judgment considerations:

………………………………Jess……….Armin

Future Sales Growth…….05.00%……..07.50%
Future EPS Growth………05.00%……..08.60%
High PE…………………….20.4………….19.0
High Price………………..$91.60…….$101.10
Low PE……………………..16.5………….15.0
Low Price…………………$57.80 (*)…. $49.30 (*)
Upside/Downside………..14.1…………..03.5
Total Return…………….. 10.6%………..12.5%
SSG Current Price……… $60.04……… $60.74
SSG Date………………….7-5-06……….6-2-06

- Jess’s 5% 5-yr estimated gowth of Earnings Per Share (EPS) seems way too low to me as 7% was the LOWEST long-term EPS estimate among 34 analysts at First Call, Zacks and Reuters when I did my SSG. 10% was the consensus estimate among the all the analysts, including S&P, while Value Line was the lowest at 8.5%. Moreover, all of the analysts had reduced their current estimates from three months earlier;

- I used the Reuters 5-yr EPS estimate less one Standard Deviation that the website (www.Reuters.com) provides at no charge. I did so only after checking five different long-term estimates which allows me to judge which average is out-of-whack or not-very-reliable as the result of only a few estimates (an average of 16 or so analysts is better than only 6 or 3). Also, JNJ’s Standard Deviation was low, only 1.64, indicating good agreement among the 13 Reuters analysts. Jess used 5%, not wanting to exceed his Sales growth estimate.

- One of the general rules by EllisT, a NAIC gonzo-guru, is never to estimate EPS growth higher than Sales growth. However, JNJ has a long history of EPS growth exceeding Sales growth and, significantly, that difference is growing larger. Based on NAIC’s S&P Stock Data Service (old OPS), EPS growth exceeded sales growth by an average of 3.80%/yr between 1996-97-98, 4.23%/yr between 1996-97-98, and by 5.07%/yr between 2003-04-05. I think it is a mistake to always estimate Sales and EPS growth at the same rate for JNJ;

- Sales and EPS growth has been slowing, especially in the last two years, which makes estimating JNJ’s future growth extra hard. I choose to use the Reuters EPS estimate less one Standard Deviation (10.23 – 1.64 = 8.59 or 8.60 rounded). The Preferred Procedure depends heavily on our Sales growth estimate which I found too “iffy” for JNJ;

- VL’s estimated Sales per sh is 6.5% but VL makes no estimate of future Sales. Jess says he computed 5.0% from VL’s data, but I compute 5.51% using VL’s method [PV = ave of 3 base years; FV = 3-5 yr est; N = 6, midpoint of PV base period to midpoint of FV est; Compound Annual Growth Rate = 5.51%]; see the JNJ example in VL’s explanatory manual, page 14, grey shaded box which is available from valueline.com at no charge. I prefer a different method which reults in 4.93% CAGR [PV = 50514 (2005, last year actual); FV = 64250 (est 2009-2011 sales); N = 5; CAGR = 4.93]

- Jess’s Forecast Low Price of $57.80 is very close to his SSG’s current price of $60.04…and accounts for his unusually high U/D of 14.1. A much lower Low Price seems indicated;

- Value Line’s estimated High Price is $85-100 and both SSGs seem close enough. However, one of my few general rules is never to substantially exceed VL’s estimate without a good reason. I never say never!!

armin

**Jess used what I call the growth company option for his Low Price, but did not use TTM low EPS while I used the Average Low Price for the last 5 years because it was the lowest option.

Declining Growth Rates at JNJ Are Troubling

Johnson and Johnson’s (JNJ) fundamentals reveal disturbing trends.

Growth rates have been declining in Trailing Twelve Month Sales for the past 8 consecutive quarters, TTM EPS for the past 7 quarters, and TTM Pre-Tax Profits (PTP) for the past 5 quarters. Here are the numbers from the PERT-A Worksheet based on S&P data from NAIC as of 7-12-06, with the last reported quarter being 3-06 as of today:

…………………….PERT-A % CHANGE

……………Col R………..Col S………..Col T
………….TTM EPS….TTM PTP……TTM Sales

09-03…….17.4………..15.6……….13.9
12-03…….16.7………..13.2……….15.3
03-04…….17.7………..15.1……….16.7
06-04…….17.8………..15.9……….15.8 dn
09-04…….17.2 dn……14.7……….14.6 dn
12-04…….17.0 dn……16.9 ………11.5 dn
03-05…….15.1 dn……14.9 dn…..11.5 dn
06-05…….14.1 dn……13.0 dn…..11.5 unchanged
09-05…….13.7 dn……12.0 dn…..10.5 dn
12-05…….11.9 dn……08.0 dn…..06.7 dn
03-06…….09.7 dn……05.3 dn…..04.2 dn

JNJ’s 5-year historical growth rate for EPS has been 16.5% and 11.8% for Sales. Its 10-year growth has been 14.4% for EPS and 10.6% for Sales. This last quarter, JNJ’s 4.2% TTM Sales growth is the lowest its been in the past 18 quarters.

During the same 18 quarters, the 8.0% TTM Pre-Tax Profit growth has never been lower. And, on a quarterly year-over-year basis which is not set forth here, the PERT-A is also disturbing. Growth has slowed in EPS, Pre-Tax Profit and Sales (cols D, G and I) for the past 5 consecutive quarters. For the first time, Sales growth turned negative in the 12-05 quarter….goint back up to an anemic 1.2% growth in the 3-06 quarter.

Value Line also commented on the 2005 Sales decline in its 3-3-06 report.

QUESTIONS:

(1) JNJ is a mature company and slower growth is to be expected. But how do we decide how much slowing is a solid indicator of deteriorating fundamentals and a red flag signal to sell?

(2) Morningstar’s Pat Dorsey wrote on 2-6-06 that “it seems like slowing growth in pharmaceuticals is one of the reasons why J&J’s shares have been whacked lately” and he was not troubled by that slow down. However, my PERT-A shows ever declining growth in Sales and in EPS for almost two years and in Pre-Tax Profit for one year. Something more is happening than just slowing sales growth.

(3) What else helps to explain these declines and how would you interpret them??

armin