by Lawrence Meyers | February 1, 2012 11:02 am
The trend is your friend. So when you see a string of earnings reports that tell you a certain story about a company, it’s really a bad idea to ignore it. As my old math teacher[1] once told me, “If the book says there’s a monster at the end of this book, there’s going to be a monster at the end of this book[2].”
The monster at the end of Johnson & Johnson‘s (NYSE:JNJ[3]) book is that it is a moribund company that isn’t growing and hasn’t been for some time. JNJ’s sales increased 5.6% YOY, and net income increased 5%. It took three years for Johnson & Johnson to exceed its 2008 sales figures. The company believes FY 2012 net income will only rise 1% to 3% on a 3% to 5% sales increase.
Now, don’t get me wrong — Johnson & Johnson is a fine company. It makes zillions of great products[4] and drugs, it produces free cash flow in the $15 billion range annually and it yields a 3.5% dividend. But JNJ is one stock in a market of many thousands of investments. There are so many other choices available that offer better risk-adjusted returns. In January 2002, JNJ stock was at the same price at it is today. If you’ve parked your money in JNJ, all you’ve done is collected a taxable dividend.
Now I understand that some people are looking for really secure investments that aren’t going to experience a lot of volatility, and maybe collect a little dividend along the way. Well, AT&T (NYSE:T[5]) also has gone nowhere since 2002, and its dividend is at 6%. That’s just one option. Preferred stocks[6] offer much better risk-adjusted returns, with a diversified ETF basket of them — the iShares S&P U.S. Preferred Stock Index Fund (NYSE:PFF[7]) —
yielding 7%[8].
There’s just no reason to hold JNJ, so I say sell it. Do not, however, short it. You only should short stocks that have a fundamental flaw in their business model or clearly are going to go bankrupt[9].
Along these lines, we all deserve a break today, but I suggest you only take that break by eating at a McDonald’s (NYSE:MCD[10]) rather than buy the stock.
In this case, we actually have a stellar company that is growing, and growing very nicely[11], at a 10% annualized clip. McDonald’s benefited a lot from the tighter purse strings of most consumers over the past few years. And once again, it produces some $4 billion annually in free cash flow and pays a 2.8% dividend.
The trouble with Ronald McDonald’s House of Finance is that the stock is vastly overpriced[12]. Back in October, I wrote about McDonald’s[13] with the controversial suggestion to sell it, because I felt a $100 stock price was all the company deserved — in 2015. At the time, the stock was at $90. Now it’s at $99.
OK, so you missed out on that 10% gain. But at this point, I wouldn’t expect much more for some time. I’d fill up on some other menu selection, because McDonald’s is trading at a P/E of 17, which gives it a PEG ratio of 1.7. In my estimation, you can assign a 13 P/E to a premium company like this. At $5.72 in 2012 earnings, that means I see fair value at around $75.
As of this writing, Lawrence Meyers[14] did not hold a position in any of the aforementioned securities. He is president of PDL Capital, Inc.[15], which brokers secure high-yield investments to the general public and private equity. You can read his stock market commentary at SeekingAlpha.com[16]. He also has written two books[17] and blogs about public policy[18], journalistic integrity[19], popular culture[20] and world affairs[21].
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