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Monday, July 13, 2009

'J&J: Secrets of Success' and Slight Parallel to AOB

We wanted to highlight a 4/22/09 Fortune magazine article by Geoff Colvin and Jessica Shambora entitled "J&J: Secrets of Success". The online article also includes a five minute interview with CEO Bill Weldon, which is worth a listen while perusing the text. Both the article and the interview succinctly outline how Johnson & Johnson (JNJ, $57.72) manages for the long-term and succeeds by putting customers first (i.e. applying Business 101 principles). The consistent, reliable performance of J&J through the years is perhaps best illustrated by the company's share price performance noted in the article:

"If you'd bought a single share when the company went public in 1944 at its IPO price of $37.50 and had reinvested the dividends, you'd now have a bit over $900,000, a stunning annual return of 17.1%. Even if you hadn't reinvested the dividends, that single share would now be 2,500 shares as a result of splits, and you'd be collecting dividends of $4,500 a year from that $37.50 investment."

Of course, aside from steadily higher dividends, the stock hasn't moved over the past five years and is only marginally higher over the past ten (but still much better than the S&P's performance):

With 2008 revenue of $64 billion, the mere size of the company -- the law of large numbers -- is a challenge to future growth and, therefore, future share price appreciation. However, JNJ is charging ahead and, according to Fortune, follows this recipe for success:
  1. Diversify within a single industry.
  2. Focus on the future.
  3. Let the experts run the business.
  4. Stay financially disciplined - always.
  5. Have a purpose beyond profits.
We believe the company's important/necessary products, global expansion, and prodigious free cash flow ($12 billion in 2008) put J&J in an excellent position to create incremental shareholder value (we know, you're probably not surprised to hear this common refrain about JNJ). Also, with a trailing P/E of 13 times and an implied 7.5% FCF yield, shares aren't egregiously priced. The company happens to report 2Q09 results tomorrow morning - brief preview from Forbes here.

Yet, with an ability to invest in all types and sizes of companies, we're generally angling for businesses with somewhat smaller market capitalizations. J&J's market cap is $159 billion and the company is one of thirty Dow Jones components. Numerous research studies support the view that smaller companies purchased with low multiples tend to outperform larger companies purchased at similar multiples (per our first Blog post, please see: Tweedy, Browne's What Has Worked In Investing).

One idea in the health care arena that is arguably somewhat comparable to J&J, is American Oriental Bioengineering (AOB, $4.96), which we discussed at length in an earlier post. While much smaller than J&J and operating in China (emerging market risk), AOB offers current investors a 16% FCF yield. Further, AOB benefits from similar competitive advantages, including recognized brands/products that people need/want (customer habit/frequency), scale (manufacturing, marketing/selling, indirect/direct distribution partners), and intellectual property (patents/technology/know-how). Finally, management has a 100-year operating plan (book) and is planning for the very, very long-term.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long AOB.

© 2009 Jeffrey Walkenhorst
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