Tuesday, October 9, 2007

Uncork the Bullish Champagne... But Avoid the Hangover: The Case for General Electric and Johnson and Johnson, Part II

In part I of this column, I discussed how recent market developments will help large companies with strong credit ratings to replace private equity groups as the players best positioned to buy out smaller companies. In this column, I will go into more depth about a few of the characteristics that make Johnson and Johnson (JNJ) and General Electric (GE), two of the many companies that benefit from this trend, such good investments at current prices. These companies share the following outstanding characteristics:

  • Exceptional track records of making smart acquisitions (and smart divestitures)
  • They are well positioned to ride long-term macroeconomic and demographic trends
  • They have a long history of shareholcder-friendly dividend policies

Smart Acquisitions, Smart Divestitures

Both JNJ and GE have a long history of finding good businesses to acquire, and successfully integrating those businesses with existing businesses after each acquisition. As I mentioned in my previous column, GE took advantage of the liquidation of Enron to buy that company's wind power assets, which gives GE a strong position as the demand for green electricty continues to soar in response to forward-looking regulations. GE also made a smart move when it divested its slow-growing plastics business for $11 billion.

Johnson and Johnson recently purchased Pfizer's Consumer Healthcare business, adding an armada of well-known consumer staples brands to its already impressive fleet of products. Have a cut? sterilize it with Neosporin, and then dress it with a Band-Aid. Quitting smoking? Some Nicorette gum will help. Not so successful in your attempt to kick the habit? Then you'll need some Listerine to cover that up from your spouse. With so many staple products in its fleet, you would have to go out of your way to avoid generating sales for Johnson and Johnson on your next visit to the grocery store - never mind the money that they will make on your next trip to the hospital.

A Foot in the Future, A Foot in the Past

But, you say, consumer staples are a boring, old-economy business. What is forward-looking about acquiring consumer staples brands? Quite a bit. In Jeremy Seigel's The Future For Investors, the author examines the long-term returns of companies in the Standard and Poor's 500 index, and draws the following conclusions:

The consumer staples sector has been marked by unusual stability. Most of the largest firms in this sector have been around for fifty years or more, and provided investors with superb returns.

Unusual stability and superb returns are a winning combination in my book. Additionally, if you consider that any healthcare reform legislation that comes out of Washington D.C. in the next few years is much more likely to negatively impact the makers of pharmeceuticals and medical devices, rather than the makers of consumer staples brands such as Listerine and Nicorette, then this acquisition makes even more sense. By adding additional consumer staples brands to the company with this acquisition, Johnson and Johnson has reduced its exposure to the political uncertainty that is a fact of life in its core health care businesses. And regardless of what sort of health care reform comes out of Washington, demographic trends assure that Johnson and Johnson will do well as the United States moves from spending 16% of GDP on healthcare to 20% of GDP on healthcare in the next 20 years.

GE Places Bets on the Future of Energy and Water

Speaking of staples, few things are as essential as energy and water - and GE is no slouch when it comes to looking toward the future and finding ways to align itself with long-term trends in these areas. It is well positioned to benefit from the current (and worsening) energy shortage by selling the world's most fuel efficient locomotive. On the power-generation front, GE will benefit regardless of whether we get more of our electricity from nuclear, coal, or wind energy - after all, they build equipment needed to generate electricity from all of those sources. Even the looming world water shortage will benefit GE as the foremost leader in desalination technology, which converts sea water into drinkable water.


So how does all of this smart planning benefit you as a prospective shareholder? Both GE and JNJ sport higher-than-average dividend yeilds of 2.7 and 2.5% respectively, and have a long history of increasing their earnings and dividends over time. It is rare to find such a combination of strong performance, high dividends, and good prospects for the future in one company, much less in two companies at the same time. I own a few shares of each of these companies for the long term, and you could do worse than to buy a few shares for yourself. My 12-month price target on GE is $52, and my 12-month price target on JNJ is $75.

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