• June 3, 2023

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Recap From April’s Picks

On a price return basis the Dividend Growth Stocks Model Portfolio (-4.2%) outperformed the S&P 500 (-7.1%) by 2.9%, and on a total return basis the Model Portfolio (-4.0%) outperformed the S&P 500 (-7.1%) by 3.1%. The best performing stock was up 6%. Overall, 22 out of the 30 Dividend Growth Stocks outperformed the S&P 500 from April 28, 2022 through May 25, 2022.

The methodology for this model portfolio mimics an All Cap Blend style with a focus on dividend growth. Selected stocks earn an attractive or very attractive rating, generate positive free cash flow (FCF) and economic earnings, offer a current dividend yield >1%, and have a 5+ year track record of consecutive dividend growth. This model portfolio is designed for investors who are more focused on long-term capital appreciation than current income, but still appreciate the power of dividends, especially growing dividends.

Featured Stock From May: Johnson & Johnson


Johnson & Johnson (JNJ) is the featured stock from May’s Dividend Growth Stocks Model Portfolio. I made Johnson & Johnson a Long Idea in February 2020 and the stock is up 24% compared to a 32% gain for the S&P 500 since then. JNJ still offers excellent risk/reward.

Johnson & Johnson grew revenue by 4% compounded annually and net operating profit after-tax (NOPAT) by 5% compounded annually over the past decade. Johnson & Johnson’s NOPAT margin improved from 20% in 2011 to 23% over the trailing twelve months (TTM). Though the company’s return on invested capital (ROIC) fell from 16% in 2011 to 15% over the TTM, its economic earnings, the true cash flows of the business, rose from $9.9 billion to $16.1 billion over the same time.

Figure 1: Johnson & Johnson’s NOPAT & Revenue Since 2011

FCF Exceeds Dividends by Wide Margin

Johnson & Johnson has increased its dividend in each of the past 60 years. The company increased its regular dividend from $3.32/share in 2017 to $4.19/share in 2021, or 6% compounded annually. The current quarterly dividend, when annualized, equals $4.52/share and provides a 2.5% dividend yield.

More importantly, Johnson & Johnson’s strong free cash flow (FCF) easily exceeds the company’s growing dividend payments. From 2017 – 2021, Johnson & Johnson’s cumulative $59.6 billion (13% of current market cap) in FCF is 1.2x the $49.9 billion in dividends paid out, per Figure 2. Over the TTM, the company generated $23.1 billion in FCF and paid out $11.2 billion in dividends.


Figure 2 also shows that Johnson & Johnson’s FCF significantly exceeded its dividend payments in four of the past five years. The company’s $30 billion acquisition of Actelion was the primary driver of its negative FCF in 2017.

Figure 2: Free Cash Flow vs. Regular Dividend Payments

Companies with FCF well above dividend payments provide higher quality dividend growth opportunities because I know the company generates the cash to support a higher dividend. On the other hand, the dividend of a company where FCF falls short of the dividend payment over time cannot be trusted to grow or even maintain its dividend because of inadequate free cash flow.

Johnson & Johnson Has Upside Potential

At its current price of $178/share, JNJ has a price-to-economic book value (PEBV) ratio of 0.9. This ratio means the market expects Johnson & Johnson’s NOPAT to permanently decline by 10%. This expectation seems overly pessimistic for a company that has grown NOPAT by 7% compounded annually over the past two decades.

If Johnson & Johnson’s NOPAT margin falls to 22% (three-year average) and the company grows NOPAT by just 3% compounded annually for the next decade, the stock is worth $244/share today – a 37% upside. See the math behind the reverse DCF scenario.

Should the company grow NOPAT more in line with historical growth rates, the stock has even more upside. Add in Johnson & Johnson’s 2.5% dividend yield and history of dividend growth, and it’s clear why this stock is in May’s Dividend Growth Stocks Model Portfolio.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I make based on Robo-Analyst findings in Johnson & Johnson’s 10-K and 10-Qs:

Income Statement: I made $4.7 billion in adjustments with a net effect of removing $922 million in non-operating expenses (1% of revenue).

Balance Sheet: I made $90.5 billion in adjustments to calculate invested capital with a net increase of $6.8 billion. The most notable adjustment was $15.6 billion (11% of reported net assets) in asset write-downs.

Valuation: I made $71.1 billion in adjustments with a net effect of decreasing shareholder value by $14.1 billion. The most notable adjustment to shareholder value was $28.5 billion in excess cash. This adjustment represents 6% of Johnson & Johnson’s market value.

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.


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