If We Could Only Hold One Stock…
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Johnson and Johnson (JNJ) might be the best stock to own if we could only hold one. For starters, the company has an incredible track record of 63 years of consistent dividend growth. It’s also a company that’s diversified into multiple areas of healthcare. Finally, it’s consistently one of the highest-scoring stocks in our Quantigence Dividend Growth Investing Report. This company demonstrates many factors of a quality company, which we’ll teach you about today.
If You Could Hold Only One Stock
If you had to hold one stock for the rest of your life which stock would that be you probably get lots of predictable answers: Tesla, Amazon, Microsoft, and there’s nothing wrong with these names.
But the answer isn’t important, it’s how you arrive at the answer. Want to know how we go about answering this question? Want to know which stock we’d select? We’ll tell you that, but again the answer doesn’t matter you should watch this because we’re going to teach you three lessons on how to become a better investor. So if we’re thinking about answering this question, the number one criteria here should be longevity so it needs to survive for, let’s say, 50 to 80 years. So if you’re 20 years old and you live to be 100, it would need to survive for 80 years.
When answering a question of this magnitude, we need to take a top-down approach starting, I think, at the sector level. So no funds or ETFs are allowed, obviously, and what’s the next best thing? Well, a conglomerate because it’s inherently diversified. Of course, there’s what they call the conglomerate discount as a result of that diversification. But if you’re thinking about longevity, then that’s a good thing.
Now when we look at the various sectors out there, there’s 11, at least according to GICs. And when we think to ourselves which sectors probably always going to be in demand, well a good argument could be made for healthcare. So a healthcare conglomerate might make a whole lot of sense here.
So the first lesson is that if you’re going to make some grand proclamation about a particular stock, provide the method you used to get there. This will allow others to critique your approach, not your selection. So our approach, given the task at hand, is to minimize the risk of systemic failure and, of course, it extends beyond just this exercise. You should always invest in quality companies and then hold them forever.
So how do we find quality companies? I think a good analogy there would be to how a hiring manager finds quality candidates. I worked as a hiring manager for over a decade at a leading Financial Services firm and HR would vet a giant stack of CVS and I would get a short list stack. I’d then go through and file all the ones with typos in the circular filing cabinet and schedule rounds with those that looked appealing. 30- minute rounds. I think in the first 5 minutes, you’ve probably eliminated 30% of the candidates.
So having a filter that allows you to quickly get rid of the junk is always a good idea. What I found is that a great candidate would often make you go over the 30 minutes of interview, while a mediocre candidate, you couldn’t wait to get out of there. So then I would go to whatever BSD was free and say I think I found a possible candidate BSD and then we would have two more interviews and two out of three would make the decision.
How does HR arrive at that short list or a hiring manager? They look at a past track record of accomplishments, whether that’s in the workplace or academics. So when I’ve looked at hiring candidates, I always asked HR to go and get me a list of people who were accepted at the top five investment banks in the associate program but weren’t extended an offer afterwards. The reason I did that is because I knew that they had proven they could do something extremely difficult.
Dividend Kings
So let’s extend that to stocks, only 0.36% of the companies in the world have done what extraordinary feat? Well, they’ve increased dividends for at least 25 years in a row. There’s only a couple hundred stocks that have ever done that and there’s about 55,000 stocks in the world.
Now some firms have done something even more remarkable and that is increased their dividends for 50 years in a row. Imagine working somewhere and getting a raise for every single year that you worked there for 50 years in a row. It’s quite as astonishing. Buffett calls these Equity bonds.
So the company that we’re going to talk about today is Johnson and Johnson. They’ve been increasing their dividend for longer than these characters have been alive. What’s interesting, in looking at this set of individuals celebrities, as they’re called, the gentleman in the upper left there, Mr. Tom Cruz, is probably the most famous of all of them.
And what is he famous for? He’s famous because his job is to pretend to be someone he’s not. So we shouldn’t be surprised to see all these people on social media doing the same thing, right? So J&J has increased their dividend, they’re dividend King, for over 60 years, we have 63 noted in our data.
How to Determine Quality Stocks
What’s lesson two? When evaluating the merits of any given stock, look backwards, not forwards, to determine quality.
What have you managed to accomplish during your career? What makes you so special? And the newer the company -and the same with candidates, the younger the candidate – the less established their track record, the more risk you take of systemic failure. So when we look at a universe of companies that have not only paid but increased a dividend for 25 years in a row, at least, we see and we rank them.
This is our Quantigence strategy, ranking dividend Champions across seven factors. We see J&J is consistently ranked at the top of our list of Healthcare Champions.
So question here, how fast has income been growing lately for this company? So we talk about dividends growing, well, how fast are they growing? Here you can see consistent mid-single digits for J&J.
On the lower right there you can see their 10-year growth rate is around 6% and so is the three and five years so they’re consistently increasing by 6%, that’s enough to offset inflation at 3%. The lower left here, you can see their yield. Some people will say, well, I’m not going to buy J&J unless they have a yield above 4%. Well, it never gets there because this is a quality name. Now when we think about the sustainability of income, so 63 years is a long time, one factor we use to look at is payout ratio and the way you calculate that is you look at the percentage of a company’s earnings paid out as dividends to shareholders.
Well, as the old saying goes, “profits are an opinion, cash is a fact.” So what we can do, we like to do is look at free cash flow versus dividends being paid. That’s pretty intuitive, right? And this chart helps us understand that. This is from J&J, this is their Capital allocation strategy.
So a business generates cash, a profitable well-established company, at least. And from that cash, they then need to deal with organic growth business needs, right? So what does the business need to continue growing? The money they have left over is called free cash flow. They can do any number of things with that including giving it back to investors. So here you can see, for J&J, they have a choice to make: they can either invest in M&A, so acquire growth, or they can pay- give money back to shareholders, that’s paying a competitive dividend, or repurchasing shares.
By the way, in the upper right here, I’ve noted their debt versus cash and net debt. Now when you’re producing $18 billion in free cash flow, managing that debt is fairly easy, that’s why they have a triple A-rated balance sheet. Always pay attention to Credit Agencies when it comes to a company that has lots of debt. So we can see here that if they generated last year $18 billion in free cash and they gave back to shareholders in the form of dividends, $11.8 billion, notice how they also gave back in the form of share repurchases but that program’s complete.
So just looking at dividends, that’s a free cash flow payout ratio of 66%. What does that tell us? Well, if nothing changed and they always had $18 billion in cash flow and they wanted to continue increasing that dividend at 6%, how long could they do it?
Well, they have eight years. You see the table on the left, we’ve just calculated that out. Eight years before that dividend payment exceeds free cash flows. But free cash flows do change. You can see the chart on the right, 18 billion is actually a bit lower than what they have had in the past five years.
Having a Methodology
So lesson three, always have a very simple method you can use to gauge the quality of any given company.
Now we use seven factors, as you saw before, to produce an industry agnostic Q-score when it comes to Dividend growth stocks. Our objective method is simple, replicable, and transparent. So anybody can look at the raw data and calculate that themselves in an Excel spreadsheet. So the other part of this lesson would be having objective rules and following them. For example, we sell dividend growth stocks for one reason only: if they stop increasing their dividend. For J&J, if- the only reason we would ever sell that stock is if they stopped increasing their dividend.
So we haven’t talked about what they do but if you go to a fact sheet of the company, I liked this across the top here. They provide you with three interesting factoids.
- The first is their operational sales growth. So they also refer to this as Constant Currency but it’s removing currency from the equation, that’s the label they’ve given to that. They have compound annual growth over the past 10 years of 7%. So they’re showing growth.
- The second factoid of sales. 25% of sales come from products launched in the past 5 years, showing that they can innovate, right? They don’t just have some cash cows they’re sitting on.
- And this third part here: of their sales, 65% of them come from a number one or number two global market share position. Well, leadership is a great place to be. We always like to invest in leaders. And along the bottom here, you- we just noted their separation from consumer health and that spin-off that we’ve talked about before.
But what’s left are two business segments: you see what they refer to as Innovative Medicine and MedTech, MedTech being a smaller percentage of their total sales and you can see the growth in the table in the upper left.
But on the upper right, rather interesting. So this is adjusted income by segment. So their Innovative medicine segment is a whole lot more profitable than MedTech. MedTech’s probably- you’d have to look at the growth factors they typically, MedTech businesses, grow fairly fast, just based on the nature of their platform. So on the bottom there, I thought this was interesting. They have a portfolio approach, as most conglomerates do. You see these are platforms and products that generate a billion dollars in sales or more.
So very strong company and quite diversified across these two segments. You see diversification within each of the various areas that they address.
And this slide taken from their last earnings release shows key events in 2023.
This may have actually been from 2023-year end, but just showing the progression of their medicine pipeline. So these are the growth stars of tomorrow.
Conclusion
So just some takeaways. A conglomerate provides its own diversification for a price, what they call the conglomerate discount and that’s a good thing if you can only invest in one company.
And health care isn’t going anywhere and you could argue it’s only getting started with a lot of the advancements today in gene editing and AI, and Robotics. But this also leads us to another very important takeaway: you should never ever hold one stock. That’s a horrible idea. This exercise is simply meant to make you think about risk. Now there are a handful of high-quality Healthcare stocks to consider using the approach we described today.
We’ve been invested in J&J for a very long time, as I said we’d only sell if they stop increasing their dividend. But it’s important to have an objective method of stock selection that removes emotion and our premium subscribers can go and take a look at the other names in our Healthcare set.
And I’m going to go ahead and leave you with another video that we did on building better DGI portfolios. If that’s something of interest, give that a watch. Thanks so much for taking the time to watch this today.
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