J&J’s Dividend, Yielding 3.5%: What You Need to Know About Cash and Growth

Even before the recent dividend-yield craze took hold, Johnson & Johnson (JNJ) was considered Exhibit A among solid dividend-paying citizens.

Long history of increasing dividends? Check. Johnson & Johnson is one of 51 current S&P 500 Dividend Aristocrats, members of the S&P 500 that have raised their dividend for at least 25 consecutive years. Johnson & Johnson's current dividend yield is abut 3.5%.

Dominant global market position that can keep the revenues streaming? Check. Johnson & Johnson’s $294 billion market cap and $66 billion in revenue eclipses its closet competitor, Novartis (NVS), which has a $151 billion market cap and $57.5 billion in revenue.

Easy-to-Grasp Business Model? Check. It’s the rare medicine cabinet or bathroom storage that doesn’t have at least one Johnson & Johnson product. As master investor Peter Lynch explained decades ago, “buy what you know” has its charms.

But lately, the great dividend stalwart is flashing some troubling signals. A confluence of pricey litigation and embarrassing product recalls and factory shutdowns contributed to a decline in profits such that Johnson & Johnson’s dividend payout ratio has shot up.

JNJ Net Income TTM Chart

JNJ Net Income TTM data by YCharts

A payout ratio approaching 80% is what you expect from a slow-growth utility. The average payout ratio for the S&P 500 is 34%.

Now to be absolutely clear, Johnson & Johnson’s dividend is in absolutely no jeopardy. Having north of $30 billion of cash in your pocket is a nice safety net.

JNJ Free Cash Flow TTM Chart

JNJ Free Cash Flow TTM data by YCharts

But if Johnson & Johnson doesn’t get its operational act together soon and earnings growth continues to sputter, the dividend could become a strategic drag for the company. If you’re spending more of your cash to ensure the dividend, that’s less money available for important R&D and acquisitions. Johnson & Johnson’s dividend obligations currently amount to 46% of its free cash flow; that’s the highest level for its cash dividend payout ratio in 10 years, and a big jump from its recent low of 35% in 2010.

Another potential complication is how the growing burden of financing the dividend could impact the dividend growth rate going forward.

JNJ Dividend Chart

JNJ Dividend data by YCharts

Growing your dividends at five times the pace of inflation is certainly impressive. But keep in mind that the most recent five-year pace of dividend hikes seriously lags the pace of dividend growth in the five prior years. From 2002-2007 Johnson & Johnson’s dividend nearly doubled. There’s little to suggest it will return to its higher growth rate. That’s fine. What remains to be seen is if it can maintain its current dividend growth rate.

As for the stock itself, well Warren Buffett has clearly decided he’s got better uses of capital. At the end of the third quarter Berkshire Hathaway (BRK.B) owned fewer than 500,000 shares of Johnson & Johnson, down from 31.5 million at the end of 2011.

Carla Fried, a contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine.

Read more articles about: Company Analysis  

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