Johnson & Johnson's (NYSE:JNJ) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?
It is hard to get excited after looking at Johnson & Johnson’s (NYSE:JNJ) recent performance, when its stock has declined 5.8% over the past month. However, the company’s fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Johnson & Johnson’s ROE today.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
View our latest analysis for Johnson & Johnson
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Johnson & Johnson is:
26% = US$17b ÷ US$64b (Based on the trailing twelve months to September 2020).
The ‘return’ refers to a company’s earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.26 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or “retains”, and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don’t necessarily bear these characteristics.
A Side By Side comparison of Johnson & Johnson’s Earnings Growth And 26% ROE
First thing first, we like that Johnson & Johnson has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 20% also doesn’t go unnoticed by us. Given the circumstances, we can’t help but wonder why Johnson & Johnson saw little to no growth in the past five years. We reckon that there could be some other factors at play here that’s limiting the company’s growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
As a next step, we compared Johnson & Johnson’s net income growth with the industry and discovered that the industry saw an average growth of 20% in the same period.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). Doing so will help them establish if the stock’s future looks promising or ominous. What is JNJ worth today? The intrinsic value infographic in our free research report helps visualize whether JNJ is currently mispriced by the market.
Is Johnson & Johnson Efficiently Re-investing Its Profits?
With a high three-year median payout ratio of 66% (implying that the company keeps only 34% of its income) of its business to reinvest into its business), most of Johnson & Johnson’s profits are being paid to shareholders, which explains the absence of growth in earnings.
In addition, Johnson & Johnson has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 48% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company’s ROE to 35%, over the same period.
Summary
In total, it does look like Johnson & Johnson has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren’t reaping the benefits of the high rate of return. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the company’s future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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