Johnson & Johnson Is Too Expensive

NEW YORK (TheStreet) -- I didn't give Johnson & Johnson> (JNJ) a strong endorsement heading into the company's second-quarter earnings report.

While I have always liked the healthcare giant, there was two things keeping from buying the stock with the own money.

First and foremost, I thought the shares were too expensive, especially since they were trading at a price-to-earnings ratio six points higher than both rivals, Abbott Laboratories ( ABT) and Pfizer> ( PFE).

Not to mention that the stock had already gained 30% on the year, so there was also the issue of value. I never believed in the idea of paying a premium for a stock when its peers are performing just as well, or even better, in some cases.

My second concern was with the company's lack of diversification.

I'm not suggesting that Johnson & Johnson is a one-trick pony. But while the company does have several highly regarded operations like orthopedics, medical devices, nutrition and (of course) drugs, it is the last that has provided all of the torque, while the other businesses have just skated by. And in this recent quarter, it was more of the same as the consumer business posted just 2% growth (in constant currency).

While the device business registered a solid 12% growth, there was also a lot of moving parts in that number. When taking a deeper look from an organic perspective, the device business posted an anemic growth of less than 2%, when adjusting out the contribution from Synthes, which Johnson & Johnson acquired last year.

This is not a situation where I'm trying to discredit the company for having made a timely acquisition. Management deserves plenty of credit for recognizing that Synthes was the right deal at the right time.

But for me to take a chance here on this stock, which already carries high expectations, organic growth details become increasingly important.

As have been the case, though, for the past several quarters, Johnson & Johnson was high in the drug business, as pharmaceutical revenue surged almost 13% year over year, which was enough to beat Street estimates by 4%. As with the first quarter, popular drugs such as Xarelto and Remicade were solid performers, with the latter up 10% year over year.

Still, it was the company's flagship drug, Zytiga, which grew a stunning 70%, that injected plenty of life into an already outstanding performance in the drugs business.

With such strong drug results, it was not surprising to see the 10% increase in operating income, which beat consensus estimates by almost 3%, but It was surprising to see the better-than-expected uptick in gross margin, which expanded by a half of one percent.

All told, it was a solid quarter for Johnson & Johnson -- I can't deny this fact. But it's also undeniable that not all of the businesses are doing equal work.

And as impressive were the operational results and strong profits, I would have much preferred to have seen better balance, even though the company's strong drug business should keep growth going for the next several years.

Even so, I have no problem admitting that despite Johnson & Johnson's strong global presence, the weak organic growth situation in medical devices and the consumer side of the business makes me nervous.

The Street, however, does not seem to care, as evidenced by the fact that the stock is up 4% since the earnings report. Johnson & Johnson has earned the benefit of the doubt. There's no arguing this fact.

But I don't believe in the long term that the company can live by drugs alone -- if you will pardon the impression.

The good news is that management issued full-year guidance that was slightly higher than that stated earlier in the year, which suggests that better operational results are on the way. But until these results become more evident, the stock remains too rich for me to buy with my own money - unless of course, I was on drugs.

At the time of publication, the author held no position in any of the stocks mentioned.

Richard Saintvilus is a co-founder of StockSaints.com where he serves as CEO and editor-in-chief. After 20 years in the IT industry, including 5 years as a high school computer teacher, Saintvilus decided his second act would be as a stock analyst - bringing logic from an investor's point of view. His goal is to remove the complicated aspect of investing and present it to readers in a way that makes sense.

His background in engineering has provided him with strong analytical skills. That, along with 15 years of trading and investing, has given him the tools needed to assess equities and appraise value. Richard is a Warren Buffett disciple who bases investment decisions on the quality of a company's management, growth aspects, return on equity, and price-to-earnings ratio.

His work has been featured on CNBC, Yahoo! Finance, MSN Money, Forbes, Motley Fool and numerous other outlets.

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