Shares of Johnson & Johnson Are Down -0.8% -- Are They Valued Fairly?

Drug Manufacturing company Johnson & Johnson is taking Wall Street by surprise today, falling to $163.36 and marking a -0.8% change compared to the S&P 500, which moved -0.6%. JNJ is -11.04% below its average analyst target price of $183.63, which implies there is more upside for the stock.

As such, the average analyst rates it at buy. Over the last year, Johnson & Johnson shares have outstripped the S&P 500 by 4.0%, with a price change of -3.8%.

Johnson & Johnson, together with its subsidiaries, researches and develops, manufactures, and sells various products in the healthcare field worldwide. The company is part of the healthcare sector. Healthcare companies work in incredibly complex markets, and their valuations can change in an instant based on a denied drug approval, a research and development breakthrough at a competitor, or a new government regulation. In the longer term, healthcare companies are affected by factors as varied as demographics and epidemiology. Investors who want to understand the healthcare market should be prepared for deep dives into a wide range of topics.

Johnson & Johnson's trailing 12 month P/E ratio is 24.3, based on its trailing EPS of $6.73. The company has a forward P/E ratio of 15.0 according to its forward EPS of $10.92 -- which is an estimate of what its earnings will look like in the next quarter. As of the third quarter of 2022, the average Price to Earnings (P/E) ratio for US healthcare companies is 13.21, and the S&P 500 has an average of 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (EPS), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.

To better understand JNJ’s valuation, we can divide its price to earnings ratio by its projected five-year growth rate, which gives us its price to earnings, or PEG ratio. Considering the P/E ratio in the context of growth is important, because many companies that are undervalued in terms of earnings are actually overvalued in terms of growth.

Johnson & Johnson’s PEG is 4.05, which indicates that the company is overvalued compared to its growth prospects. Bear in mind that PEG ratios have limits to their relevance, since they are based on future growth estimates that may not turn out as expected.

To understand a company's long term business prospects, we must consider its gross profit margins, which is the ratio of its gross profits to its revenues. A wider gross profit margin indicates that a company may have a competitive advantage, as it is free to keep its product prices high relative to their cost. After looking at its annual reports, we obtained the following information on JNJ's margins:

Date Reported Revenue ($ MM) Cost of Revenue ($ MM) Gross Margins (%) YoY Growth (%)
2022-12-31 94,943 31,089 67.26 -1.32
2021-12-31 93,775 29,855 68.16 3.93
2020-12-31 82,584 28,427 65.58 -1.26
2019-12-31 82,059 27,556 66.42 n/a
  • Average gross margin: 66.9 %
  • Average gross margin growth rate: 0.4 %
  • Coefficient of variability (higher numbers indicating more instability): 1.7 %

Johnson & Johnson's gross margins indicate that its underlying business is viable, and that the stock is potentially worthy for investment -- as opposed to speculative -- purposes.

When we subtract capital expenditures from operating cash flows, we are left with the company's free cash flow, which for Johnson & Johnson was $19,758,000,000.00 as of its last annual report. This represents the amount of money that is available for reinvesting in the business, or for paying out to investors in the form of a dividend. With its strong cash flows, JNJ is in a position to do either -- which can encourage more investors to place their capital in the company. Over the last four years, the company's free cash flow has been growing at a rate of -0.4% and has on average been $19,955,000,000.00.

Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts). Johnson & johnson's P/B ratio is 5.7 -- in other words, the market value of the company exceeds its book value by a factor of more than 5, so the company's assets may be overvalued compared to the average P/B ratio of the Healthcare sector, which stands at 4.07 as of the third quarter of 2022.

Johnson & Johnson is likely overvalued at today's prices because it has an inflated P/E ratio, an elevated P/B ratio, and a steady stream of positive cash flows with a flat trend. The stock has mixed growth prospects because of its consistent operating margins with a stable trend, and an average PEG ratio. We hope this preliminary analysis will encourage you to do your own research into JNJ's fundamental values -- especially their trends over the last few years, which provide the clearest picture of the company's valuation.

The above analysis is intended for educational purposes only and was performed on the basis of publicly available data. It is not to be construed as a recommendation to buy or sell any security. Any buy, sell, or other recommendations mentioned in the article are direct quotations of consensus recommendations from the analysts covering the stock, and do not represent the opinions of Market Inference or its writers. Past performance, accounting data, and inferences about market position and corporate valuation are not reliable indicators of future price movements. Market Inference does not provide financial advice. Investors should conduct their own review and analysis of any company of interest before making an investment decision.