Marcial: J&J, a Healthy Defensive Play

When things get tough in the stock market, it's time to play defense—and offense. That's the strategy of savvy professional investors as the major U.S. equity indexes spiral downward. Since Oct. 1, when the Dow Jones industrial average closed at 10,831.07, massive selling had driven shares down nearly 13%, to 9,447.11, by the end of trading on Oct. 7. The widening financial crises, exacerbated by fears of a looming recession plus Europe's own bout with credit problems, pummeled markets worldwide. And relentless selling by hedge funds that had to meet rising margin calls on their heavily leveraged portfolios was a big part of what caused the turmoil.

"We can't take it anymore" is a common cry among many investors. But in the worst of times, the markets create value for those willing to pluck out the "angels" that have fallen hard. Of course, investors should always strive to pack their portfolios with defensive stocks that are of star quality even in good times—companies endowed with strong balance sheets, robust cash flows, and rising sales and profitability, with little or no debt and handsome dividends to boot. Often they're in recession-resistant businesses like health care or consumer staples, and typically they don't see sharp swings in their stock prices. When the market crashes, as it is bound to do—the current environment being a perfect example—investors should be prepared to snap up quality stocks like those at a huge discount.

Johnson & Johnson (JNJ), one of the world's largest and most diversified health-care companies, is one such stalwart—both a defensive and offensive play. A major force in pharmaceuticals, medical devices, and consumer products, J&J draws its strength and sustaining power from diversification. Many of its consumer products are widely known brands, including nonprescription drugs like Tylenol and Imodium A-D antidiarrheal medication, Johnson's baby line of products, and its Band-Aid line.

J&J's pharmaceutical business has more than 90 products that are marketed worldwide, including cardiovascular, gastrointestinal, and urology products. Medical devices consist of such products as Ethicon sutures and wound care, DePuy orthopedic devices, and Cordis coronary interventional products.

Promising Drug Pipeline

"J&J's diversified sales in these three sectors, along with its decentralized business model, has served it well in the past and should continue to do so in the years ahead," says Herman Saftlas, health-care analyst at Standard & Poor's, who rates the stock a strong buy. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP).)

True to its defensive characteristics, the stock has traded within a narrow range of 61 to 72. It climbed last month to a 52-week high of 72.76 on Sept. 9, after hitting a 52-week low of 61.17 on Mar. 10. With all of the market's gyrations, J&J is trading now at 63. Saftlas has a price target of 77 on the stock, based on his earnings estimates of $4.50 a share in 2008 and $4.75 in 2009, up from 2007's $4.15.

David Roman, health-care analyst at Morgan Stanley (MS), who rates J&J outperform, has a higher valuation of 82, based on his "intrinsic value analysis," which takes into account the long-term return characteristics of the company's businesses.

The company's drug pipeline, says Roman, looks stronger now than it has in the last four to five years. New products, he says, are expected to add 47% to the company sales growth from 2008 to 2012. In its medical device and consumer products operations, the businesses are generally strong, says Roman, with leader J&J gaining market share in most segments. One source of more upside potential: operations in emerging countries. The company's diversified business model supports the stability and predictability of its earnings growth, he notes, despite near-term pressure in its pharmaceutical business as some of its drugs go off patent and cheaper generic versions become available.

A Stock for All Seasons?

S&P's Saftlas says revenues and cost synergies from the company's 2006 purchase of Pfizer's (PFE) consumer products unit should help drive earnings growth and boost cash flow, even as the medical device and drug operations face pricing pressures from rivals.

"J&J's stock offers solid value during the current volatile stock market," says Saftlas. In the past five years, from 2002 to 2007, the company generated annual growth in worldwide sales of 11% and operating earnings growth of 9.5%. He expects J&J to chalk up annual sales growth of about 7% and operating earnings growth of some 9% during the years 2008 through 2010. At the end of June 2008, J&J had cash and investments of $13.9 billion and debt of about $13 billion.

J&J can best be described as a pharmaceutical company with products for most everybody's needs. And its defensive qualities—coupled with its growth prospects—could well make it a stock for all seasons.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.