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November 2, 2005

Recommendation on JNJ, Wed., Nov. 2, 2005, 2:41 PM

I like JNJ. The company is a first-class operator in the healthcare products business. It has been depressed because of difficulties in its proposed deal to acquire Guidant. Without going into that situation except to say there is a $700 million break fee involved, and some likely litigation ahead, the stock at $61.20 is close to my desired purchase level at $60.

Based on the five-year growth prospects that are good (but not as good as the past 10 years) and the Value Line estimated 2006 earnings of $3.80 (which I'll knock back to $3.75) times VL's projected PE of 20 (which I think is ok), I would expect to have a price of $75 within 12-15 months. The dividend yield presently is about 2.2 pct.

So if I buy JNJ my return would be 75-60=15/60=25pct. With the dividend of $1.32 (2.2 pct on $60), I'd be happy with a total annual return over +27 pct for next year. As I say, those are Buffett numbers.

There is a different way to play this stock: write the April-06 put options with a 60 strike.

The current market is $2.35-$2.45 on the April-06 60 put. Say you sell the JNJ put short for premium of $2.40. If the stock stays over $60, you keep the premium as your income. If the stock drops below $60 and is put to you by the buyer of the put you sold, your cost is $60 minus $2.40 you already got as the premium, for a total cost of $57.60.

If JNJ then moves up to $75 within 12 months, your return would be 75-57.60=17.40/57.60=30.2pct, not including the dividend return. So those are better than Buffett numbers.

If JNJ drops even further, you can add to positions with the belief that this is a financially solid company with high stock price stability and earnings predictability (per VL). JNJ is really a core holding for most portfolios.

Now, that is how I work these stocks into my portfolio. And over the years, if I just add premium, then my JNJ cost base drops, meaning my risk drops, and my earned dividend yield increases, but I am also happy that the stock price itself is growing. In addition, if the Weekly and Monthly RSI drops down (for whatever reason as price reverts to the mean, such as with the present Guidant issue), then I can add to my holdings of a company that I can count on to increase my wealth.

After all, this is a company that enjoys a Return on Capital averaging +22.5 pct, and a Return on Equity averaging +24.5 pct. Your house price increase might beat those numbers once in 20 years, so what's not to like about a first-class stock like JNJ.

Have a read of the Value Line report, the Yahoo Finance data, and the Investertech interactive price chart on JNJ. The VL report is dated Sept 2. The next one will come out December 2.

(JNJ) (JNJ) Here is the Sep. 3 Value Line report on JNJ: next one is due Dec. 2)

Enjoy.

Posted by Posted by Bill Cara on November 2, 2005 02:42:05 PM | Category: 35 Health Care

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