This article was coproduced with Dividend Sensei.

Most of my followers know I provide readers with a weekly non-REIT article that’s usually retirement focused. And I make it very clear in the titles when that happens.

That messaging serves a few purposes, as I explained in a previous article:

“My mom is now officially retired, you see. And she’s on the prowl for safe dividend growth stocks. So every time I put “retire” in the title, it’s a signal for her to spot.”

For that matter, I’m focused on building my own personal retirement portfolio. And as a matter of due diligence, I’m always looking for ways to diversify beyond REITs through other dividend-paying stocks.

Last but certainly not least is that I want all of you to enjoy the fruits of my labor, including when it comes to one of the highest-quality dividend kings on the planet.

Because that’s precisely what Johnson & Johnson (JNJ) is, and it’s now on sale.


The Ultimate Retirement Super SWAN

There are many proven ways to compound income and wealth on Wall Street. Buying companies with several co-called “alpha factors” is just one of them, though perhaps one of the best.

Johnson & Johnson, for example, combines low volatility, dividend growth, and supreme quality. The result is an ultimate sleep-well-at-night package that’s beloved by retirees, and for very good reason.

JNJ has been beating the S&P 500 for the last 34 years, and with incredibly low volatility during some of the most stressful times on Wall Street.

It may be a boring and steady company. But these are precisely the kind of companies that can help construct a dream retirement portfolio – no matter what the market or economy is doing.

JNJ Rolling Returns: The Ultimate Proof of Supreme Quality

(Source: Portfolio Visualizer)

JNJ’s average rolling total returns more than the last 34 years has significantly outperformed the S&P 500. As Ben Graham says, over the long term, the market almost always correctly “weighs the substance of a company.”

In this case, the verdict is clear: We’re looking at one of the highest-quality companies on earth. And considering what’s going on right now, that sounds especially good to us.

The third wave of the pandemic has prompted France and Germany to relock down for a month, sending U.S. stocks into a tailspin. On Wednesday, the S&P 500 plunged 3.5% in the worst day since June.

That drama was intense enough to send even JNJ – normally such a defensive stock – tumbling more than the S&P 500. That makes no long-term sense, creating a short-term opportunity for prudent long-term investors to lock in some very attractive volatility-adjusted returns.

Over the past 34 years, JNJ’s volatility-adjusted total returns were 14% better than the S&P 500. And over the next 30, analysts expect them to be 11% better.

What’s not to like for an intrepid retiree or retiree in the making? But here are the four reasons we really like it anyway.

Reason 1: The Safest Dividend In The World

To determine dividend safety, Dividend Kings uses a 28-metric model that looks at the sustainability of the payout and balance sheet.

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Working off of that, JNJ scores a perfect 5/5 on dividend safety. This equates to a mere 1.5% risk of a cut in this pandemic, as demonstrated below:

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And here are some more facts and figures to back that up, including how Johnson & Johnson has a:

  • 2020 free cash flow consensus payout ratio of 80% versus 60% safe for big pharma (outside of recessions)
  • 2021 FCF consensus payout ratio of 55% versus 60%
  • 2022 FCF consensus payout ratio of 50% versus 60%
  • 2023 FCF consensus payout ratio of 49% versus 60%
  • Debt/EBITDA of1.5 versus 3 or less safe
  • Historical debt/EBITDA of 1 versus 3 or less safe
  • Interest coverage ratio of 129.6 versus 8+ safe
  • Historical interest coverage ratio of 31.3 versus 8+ safe
  • Debt/capital of 31% versus 40% safe
  • Current ratio of 1.48 versus 1+ safe
  • Historical current ratio of 1.88 versus 1+ safe
  • Quick ratio of 1.24 versus 1+ safe
  • Historical quick ratio of 1.44 versus 1+ safe
  • S&P credit rating of AAA with a negative outlook = 0.07% 30-year bankruptcy risk
  • Moody’s credit rating of Aaa (AAA equivalent) with a negative outlook = 0.07% 30-year bankruptcy risk
  • Dividend growth streak of 58 years
  • F-score of 6 versus 4+ safe, 7+ very safe = low short-term bankruptcy risk
  • Z-score of 3.98 versus 1.81+ safe, 3+ very safe = very low long-term bankruptcy risk
  • M-score of -2.63 versus -2.22 or less safe = low accounting fraud risk
  • Historical F-score of 6 versus 4+ safe, 7+ very safe = low short-term bankruptcy risk
  • Historical Z-score of 5.44 versus 1.81+ safe, 3+ very safe = ultra-low long-term bankruptcy risk
  • Historical M-score of -2.59 versus -2.22 or less safe = low accounting fraud risk.

We’ll discuss those negative outlooks in the risk section. But, in short, JNJ is looking strong, an opinion S&P ultimately agrees with. Its most recent commentary on the subject lauded JNJ’s “business strength as excellent,” including when compared to its peers. And S&P highlighted the company’s:

  • $80 billion in annual revenues
  • Strong and diverse business
  • Strong profitability
  • Market leadership position in both pharma and medical devices
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As for the latter point, it writes: “We view these businesses as particularly stable, with the pharma and medical device businesses largely insensitive to the economic cycle and protected by high barriers to entry.”

That’s an assessment we very much agree with.

Reason 2: As Close to a Perfect Dividend Growth Stock as Possible

So Johnson & Johnson has an amazing balance sheet and strong free cash flow generation. But what makes a Super SWAN a Super SWAN is the overall quality of a company, including:

  • 5/5 dividend safety
  • 3/3 wide moat and stable business
  • 3/3 exceptional management quality/dividend culture

And JNJ’s profitability – when adjusted for patent cliffs and the timing of merger & acquisition (M&A) deals – is relatively stable over the last 30 to 40 years.

It’s historically maintained profitability in the top 20% of its peers. And pharma is a relatively lucrative industry, so that’s saying something.

Overall, JNJ is in the top 9% of drug makers in terms of average profitability. There are just 85 large drug makers in the world out of 990 that were more profitable over the past year.

Joel Greenblatt, one of the best investors in history, very much relies on return on capital – the money it takes to run a business – to evaluate overall company quality and “moatiness.”

JNJ has historically generated 103% ROC. For every dollar it takes to run the business, it generates $1.03 in annual pre-tax profits. Even during a pandemic, its 12-month trailing ROC is 110%. And in Q3, it generated 100%.

Over the past five years, JNJ’s ROC also has been stable. That’s despite numerous business challenges such as patent cliffs.

Just 34 global drug makers score higher.

Reason 3: Management Quality and Dividend Culture Are Exceptional

By now, we can make some logical assumptions about management’s competence and trustworthiness. But here’s Morningstar’s opinion anyway:

“Overall, we view the stewardship at Johnson & Johnson as relatively standard. While the firm has a good record of making sound capital deployment decisions and consistently generating returns on invested capital above the cost of capital, major recalls, the recent potential overpayment for Actelion, and poor turnaround time in addressing manufacturing problems at certain key divisions lead us to a more balanced view of the company’s leadership.”

Believe it or not, that still equates to an “above average” conclusion from the ratings source.

CEO Alex Gorsky has 32 years of industry experience. Over the last six years, he’s done a good – if imperfect job – of allocating shareholder capital and dealing with JNJ’s complex risk profile.

What earns his company a 3/3 exceptional management quality/dividend culture score anyway in our book comes down to two simple facts:

  1. Its wide and stable moat has been maintained for 40 years, proving overall corporate culture is very good at allocating capital and overcoming challenges
  2. Its dividend streak of 58 years is phenomenal

With that rating added in, we’ve got a solid 11/11 super SWAN on our hands.

Reason 4: The Safest Dividend in the World Is Finally a Potentially Good Buy

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For a company of JNJ’s quality and modest risk profile, we consider a 5% discount to fair value to be a potentially good buying opportunity. And it’s finally trading at a modest but sufficient margin of safety to recommend it.

To determine whether or not a company’s historical valuations can tell us its intrinsic value, to which the stock price will always return to over time, we must know whether a company is likely to keep growing at similar rates as in the past.

Johnson & Johnson analyst consensus growth estimates include:

  • Dividend of 6% for both 2021 and 2022, with its 6% for this year already locked in
  • Earnings per share of -8% for 2020, 12% for 2021, and 9% for 2022
  • Owner earnings of 12% for 2020, 6% for 2021, and -2% for 2022
  • Operating cash flow of -16, 29%, and 8%, respectively
  • Free cash flow of -33%, 54%, and 16%, respectively
  • Earnings before interest, taxes, depreciation, and amortization (EBITDA) of 01%, 9%, and 8%
  • EBIT of 17%, 12%, and 9%

It’s true that JNJ is having a rough year, though EPS is expected to fall 10% less than the S&P 500. And earnings should rebound strongly, with various forms of cash flow flat-out soaring.

This is critically important for the purposes of deleveraging, which the rating agencies say is a must for JNJ to keep its coveted AAA credit rating.

And, for the record, its business is so stable and management guidance so accurate that – over the last 20 years – it’s never missed expectations within a 20% margin of error on two-year forecasts.

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Both the margin of error to the downside and to the upside are 10%. And the margin of error adjusted long-term analyst consensus of 5%-7% compound annual growth rate growth is reasonable given JNJ’s history and future alike.

It’s long-term catalysts include:

  • A strong position in global healthcare (50% of sales are from overseas)
  • A strong position in emerging markets, which have far larger population and GDP growth than developed markets
  • As countries get richer (and older), spending on healthcare goes up

The Graham/Dodd/Carnevale rule of thumb says that 14x-16x earnings and cash flow is a “reasonable and prudent” valuation to pay. That’s based on 200 years of market historical returns of about 7%. It equates to a 6.7% earnings/cash flow yield.

This is for companies growing at 3.25% to 15% CAGR, which includes JNJ. The 15.5-17 historical price-to-earnings ratio that billions of investors have paid for it over the last 20 years – outside of bear markets and bubbles – indicates its superior quality is worth a P/E premium of 0.5-1.5.

JNJ’s intrinsic value likely is between $140 and $164 in 2021. So the harmonic average of $149 represents a reasonable estimate of its true worth based on next year’s consensus fundamentals and current dividends.

That makes it a potentially good buy at current prices.

The stock should deliver close to 10% CAGR total returns through 2022, assuming it grows as expected and trades at historical mid-range fair value. And if it grows as expected and returns to historical fair value by 2025, analysts expect 8.8% CAGR total returns.

That makes it far superior to the S&P 500’s predicted 5.2%. Incidentally, that index remains 27% historically overvalued.

Risk Profile: Why JNJ Isn’t for Everyone

Over the long term, Johnson & Johnson’s risk profile is similar to that of all big pharma companies. It needs to overcome several legal roadblocks, including remaining litigation surrounding its central nervous system drug Risperdal, talcum powder, surgical mesh products, and opioid drugs.

Any one of those could cause major settlements and damage its sterling reputation.

Over the longer term, the company faces typical healthcare risks such as:

  • Reduced pricing power from both governments and pharmacy benefit managers
  • Regulatory delays
  • Non-approvals
  • Increasingly aggressive generic competition for both small-molecule drugs and biologics

Morningstar is particularly concerned about “the biosimilar risk to (autoimmune disease treatment) Remicade… with several biosimilars working to gain more market share.” Though it adds that, “with such a wide portfolio of products, we view the firm’s overall uncertainty as low.”

Moving on to JNJ’s fundamental risk profile, that will never change.

  • Patent cliffs
  • Regulatory risk
  • Litigation risk
  • Drug trial failure risk

All these are things healthcare investors in general need to be comfortable with. But quality management teams like J&J’s can deal with these risks, especially when said teams are working with $31 billion in cash on its balance sheet.

Its average borrowing cost is 0.52%, which is lower than the U.S. Treasury’s. On top of that, in 2021 and 2022, analysts expect that it will retain $22 billion in free cash flow.

This matters significantly considering the talcum powder litigation against J&J and it dealing with the highest leverage in 15 years.

It experienced a significant setback with the former in July 2018 when it was slapped with a $4.7 billion adverse judgment. This was subsequently reduced to $2.1 billion by the Missouri Court of Appeals this June, and the company currently is pursuing an appeal in the Missouri Supreme Court.

It also plans an appeal to the U.S. Supreme court if that fails. Though both courts can refuse to review the case, we expect the state to communicate its willingness to hear the case shortly. If that doesn’t happen, it would be a material setback for JNJ’s prospects in this regard.

The company has set aside $5.5 billion for future legal liabilities. Bloomberg intelligence estimates a worst-case scenario figure at $15 billion.

However, the history of major legal settlements is that they’re reversed on appeal or settled for about 1% or less of the initial amount.

As such, JNJ’s $5.5 billion in total legal reserves is likely conservative. Plus, such settlements aren’t paid all at once but over 15-30 years.

In short, the talcum powder liability risk may threaten JNJ’s AAA credit rating, but not its dividend or overall solvency.

Really, the main reason S&P and Moody’s just gave it a negative outlook is the $6.5 billion Momenta Pharma acquisition JNJ just announced. Though it fully acknowledges the lawsuit issue, Morningstar writes that:

Johnson & Johnson… increased its legal reserve for opioid and talc litigation by an additional $1.5 billion in the third quarter. Inclusive of the $6 billion acquisition of Momenta Pharmaceuticals Inc. (that closed on (October) 1, 2020), pro forma debt leverage was about 1.3x, representing a 15-year high for the company.

“We view this level of leverage as weak for the rating… Furthermore, given the timing of the recent acquisition, we believe the company’s tolerance for leverage in the mid-1x area may be increasing.”

Worth noting about that last statement is this: JNJ’s leverage isn’t actually high, it’s just high for a AAA credit rating.

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S&P writes this on the subject:

“We believe JNJ’s failure to prioritize deleveraging over M&A and share repurchases over the past few years, despite nearly $10 billion of annual cash flows after dividends, indicates that management may be growing increasingly comfortable with leverage approaching the mid-1x area, which we view as more consistent with an ‘AA+’ (rather than ‘AAA’) rating.”

Yet JNJ has been repurchasing stock at 0.9% CAGR over the past five years, which generated 12% of its overall earnings growth. So it does have the ability to easily retain its AAA rating if it uses that river of retained cash to pay back debt.


  • 1% annual dividend buybacks = $3.6 billion per year
  • $6.4 billion in retained FCF left to repay debt
  • 0.4 net debt/EBITDA
  • 0.3 consensus net debt/EBITDA in 2021

With $32.7 billion in long-term debt and $5.1 billion in short-term debt, here’s how fast it can deleverage:

  • JNJ can repay 17% of its total debt in 2021.
  • JNJ can repay 22% more of its current debt in 2022.
  • JNJ can repay 25% more of its current debt in 2023.

Essentially, JNJ is just such a free cash flow-minting machine.

Obviously, this doesn’t mean it can’t lose its current rating. Only that we’re not intensely concerned about it at this time.

As far as valuation risk goes, JNJ’s is modest because it’s trading at a slight discount to fair value. That fair value range is 16%, which is low, and Morningstar concurs with its “low” fair value uncertainty rating.

What’s more JNJ’s historical premium to the Graham/Dodd/Carnevale rule of thumb is a modest 0.5 to 17. Even if growth were to slow to 4% or 5%, there’s relatively little multiple compression downside to worry about.

Volatility, of course, is a factor in today’s market. And while JNJ’s is very low at a 15-year annual average of 15.3%, it can still drop sharply and suddenly, even as much as 10% in a single day, as it has before in the past decade.

Knowing that, always keep in mind to allocate your portfolio appropriately.

In Closing…

Johnson & Johnson is the king of dividend kings and the safest dividend in the world. That’s courtesy of its:

  • Global diversified recession-resistant business model
  • Over $10 billion in annual post-dividend retained free cash flow
  • Skilled and adaptable management team and exceptional dividend friendly corporate culture
  • $31 billion cash pile
  • AAA credit rating (stronger than the U.S. Treasury according to S&P)
  • 58-year dividend growth streak that’s survived eight recessions including the Financial Crisis and Great Lockdown Recession

JNJ’s profitability is among the best of any big pharma company and among the best of any company in the world. That profitability is protected by a wide moat that’s created by the same complex regulatory risks investors worry about.

It can spend months or even years overvalued, sometimes ridiculously so. So when the safest dividend stock on earth goes on sale, even by a modest 7%, it’s time for income investors to take notice – and seriously consider taking action.

JNJ isn’t right for everyone. No company is. But if you’re looking for a relatively generous and dependable source of income… that grows each year no matter what the economy or stock market is doing… then JNJ is well worth considering today.

If the idea of 9% CAGR long-term returns for the foreseeable future – with very low volatility over time – sounds good to you, then we recommend you consider starting or adding to a position in JNJ right now.

Author’s note: Brad Thomas is a Wall Street writer, which means he’s not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.

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Disclosure: I am/we are long JNJ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.