Johnson & Johnson (JNJ) Stock May Be Volatile Due to Litigation Risk

Johnson & Johnson (NYSE:JNJ) is expected to report its fourth-quarter earnings on Jan. 22. Over the past year, JNJ stock  has risen about 12%. And the share price is currently hovering around $145.

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The owners of Johnson & Johnson stock may well remember that between 2012 and late 2017, the shares rallied from $60 to $140. However, over the past two years, JNJ stock has been mostly stuck in a range between $120 and $145.

The wide breadth and stability of JNJ’s operations across the healthcare continuum make me bullish on the long-term outlook of Johnson & Johnson stock. However, in the short-term, especially prior to the release of the quarterly results, investors may decide to take some of their profits on Johnson & Johnson stock. Long-term investors may view any upcoming pullbacks of JNJ stock as an opportunity to buy the shares.

What to Expect from JNJ’s Earnings

In October, Johnson & Johnson  reported Q3 earnings and revenue that beat analysts’ average expectations. Its revenue rose 1.9% year-over-year to $20.7 billion. Earnings per share, excluding certain items, came in at $2.12, versus analysts’ average estimate of $2.01. Over the years, JNJ’s earnings growth has been remarkably consistent.

When Johnson & Johnson reports its Q4 earnings, the Street will analyze its three main segments

  • Pharmaceutical, which contributes more than 50% of JNJ’s pretax profits.
  • Consumer
  • Medical Devices & Diagnostics

These three segments combined give JNJ predictable cash flow and solid pricing power. Over the past year, it has generated free cash flow of almost $20 billion, a highly respectable number.

About 60% of Johnson & Johnson’s revenue comes from the U.S. Yet its overseas operations in general and its emerging market businesses in particular are proving to be important growth catalysts for Johnson & Johnson stock. Therefore, investors are likely to pay attention to its overseas numbers in future earnings reports, too.

You may also be interested to know that of all the publicly listed U.S. companies, only two hold a coveted AAA credit rating: Microsoft (NASDAQ:MSFT) and Johnson & Johnson. That means credit rating firms, after conducting rigorous analysis, have determined that both companies can easily pay off their debt. In other words, credit markets trust these two companies more than most governments.

The forward price-earnings ratio of JNJ stock stands at 16. Although that is not too rich for a strong business like Johnson & Johnson, if its Q3 results fall short of expectations, many investors may be ready to stop buying Johnson & Johnson stock for awhile.

Tailwinds Supporting Johnson & Johnson Stock

With a market cap of $384 billion, Johnson & Johnson is currently number 37 on the Fortune 500 list. The U.S. has an aging population, and that demographic trend will likely support demand for healthcare products and services during the next decade.

One of the challenges faced by JNJ and other drug companies is falling sales as the patents of blockbuster drugs expire, enabling much cheaper, competing generic drugs to take most of their market share.

Therefore, the pressure to innovate and diversify is part of the reality of managing a global pharma leader like Johnson & Johnson. And in JNJ’s case, diversification has been the company’s competitive advantage. As one segment faces headwinds, the others usually help propel the company forward.

Diversification also enables the company to withstand economic cycles more effectively. No matter what the economy does, consumers will buy the products of many of these strong brands, and Johnson & Johnson will have industry-leading market share in many areas.

Investors who buy JNJ stock now will enjoy a dividend yield of 2.6%.  The conglomerate has raised its dividend each year for well over half a century. With its diverse range of products as well as several blockbuster drugs, I think Johnson & Johnson stock is likely to continue to be a high-dividend name.

And dividends tend to create a “price floor” for stocks during market downturns. The trailing payout ratio of Johnson & Johnson stock is a robust 46%, meaning that Johnson and Johnson is distributing about half of its earnings as dividends.

In general, only strong, leading companies can continue to have such a payout ratio year after year.

What Could Derail JNJ Stock in the Short-Term?

Pharmaceutical firms often face legal challenges. At present, Johnson & Johnson is facing literally thousands of lawsuits and finding itself in the news for all the wrong reasons.

For example, last summer, the Federal Trade Commission issued civil subpoenas to the company in an effort to determine whether JNJ had violated antitrust laws with Remicade, its rheumatoid arthritis drug.

In August, Johnson and Johnson made the news when an Oklahoma judge found  it guilty of  helping to fuel the state’s opioid crisis by aggressively marketing painkillers. And in October, it was hit with an $8 billion punitive fine over breast growth caused by its psychotic drug, Risperdal. JNJ is also facing various lawsuits regarding its talc-based baby powder.

In the long-run, lawsuits and fines will not necessarily dent the fundamental metrics of pharma companies much. However, in the short-term, investors understandably get spooked by the uncertainty created by lawsuits. No stock is going to be entirely risk-free, and there is some legal risk surrounding JNJ stock.

Johnson & Johnson stock was quite volatile last year, and most of its gains for 2019 came during the year’s final weeks.

As a result of the recent gains of JNJ stock, its short-term technical indicators have become somewhat overextended. Investors who pay attention to short-term oscillators should note that JNJ stock has also become “overbought.”

Therefore, JNJ stock might drop towards the $137.5-$140 level, where the stock is likely to find major support in the coming weeks.

The Bottom Line on Johnson & Johnson Stock

J &J’s diversification will enable JNJ stock to withstand economic downturns more effectively than many other equities. No matter what the economy does, consumers will buy the products of many of the company’s strong brands, and Johnson & Johnson will likely have industry-leading market share in many areas.

Given the fundamental strength of the company and its dividend yield, it is easy to see why passive income-seeking investors will not easily give up on J&J stock.

However, 2019 brought legal headaches for JNJ, and the company found itself in some hot water. Although I do not advocate forming a long-term investment view about any stock based on one difficult year, many investors may continue to be worried about these legal challenges, at least through early 2020. And they may decide to take some money off the table before JNJ releases its Q4 earnings.

If you aren’t already long JNJ stock, you may want to remain on the sidelines and wait for the shares to drop. I’d also consider buying covered calls in conjunction with buying Johnson & Johnson stock. For example, covered calls with a Feb. 21 expiration could be appropriate. Such a hedge would give investors some downside protection and the chance to benefit from a potential rally.

Any short-term decline of Johnson & Johnson stock may create better entry points for long-term investors who do not yet own JNJ stock.

As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.

 

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