Johnson & Johnson's lost decade

They say the longer the base, the greater the potential gain.

One of the longest trading bases of the Dow components right now is Johnson & Johnson (JNJ-N). When Bill Weldon, the current CEO of JNJ took the top job in 2002, the stock was $65 US. Ten years later the stock is essentially in the same place. This is despite an increase in revenue of 80 percent and a doubling of profits over that time frame. And a 178 percent increase in the quarterly dividend to boot.

What went wrong and why has one of Wall Street's favourite defensive names failed to keep pace?

First, in 2002, the stock carried a price/earnings multiple of more than 30 times. Back then it was discounting continued low double-digit earnings gains not the fact of mid-single digits profits. The "e" rose but the "p/e" contracted more.

Second, in recent years, the company has stumbled in the manufacturing front, undermining its pristine reputation for quality and safety. The company has had plants closed by the FDA and product recalls in its high profile consumer products division, including the recall of children and infant Tylenol.

Third, the company started this ten-year period with a lackluster new product pipeline. While it tried to boost sales through acquisitions, the lack of new products hampered organic growth.

But this is a company with $65 billion in revenue that has a substantial consumer products footprint, new products in blood-thinning, prostate cancer and Hepatitis C and opportunities from the integration of recent acquisitions. What will be the catalyst to break the base? On April 26th, a new CEO, Alex Gorsky, takes over from Weldon providing an opportunity for change.

Unfortunately, Gorsky might be occupied by a multi-billion dollar fraud suit against JNJ.

The suit, brought by the U.S. government, alleges the firm paid kickbacks to influence sales of an antipsychotic drug to nursing home patients. Government lawyers say Gorsky should be called to testify since during the time of the alleged fraud he was JNJ's vice-president of sales and president of one of the units involved in the suit.

This might keep him distracted.

On the other hand, the stock appears cheap (12.5 times this year's expectations) with a strong balance sheet and a dividend hike pending (the street expects a four cent increase). Those facts, combined with the stock's ten-year underperformance, may be what support a closer look.