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Ignore the Bond Bubble and Follow Buffett's Lead

By: Tom Hutchinson
Posted: 9/9/2010 3:49:00 PM
Referenced Stocks: JNJ

Today's market environment might be uncertain, but one thing is certain: the crowd is flocking to bonds.

In 2009, investors put $375 billion into bond funds, about 14 times more than in 2008 and more than double the previous record in 2002. In the first half of 2010, investors put another $138 billion into bond funds, an astounding four-fifths of the total invested in mutual funds.

This buying spree has sent bond yields plunging near historic lows -- the 10-year Treasury yield recently fell to 2.57% and the two-year note recently fell to 0.49%, an all-time low.

The financial crisis and the recent spate of bad economic news have sent investors running for the safety of bonds, but are bonds that safe? Rising interest rates cause bond prices to decline. And, at near all time low levels, interest rates have no place to go but up. [Read: How to Lock in 8% Government Yields ]

One well-known investor, however, is not following the crowd. While most investors have been flocking to bonds, Warren Buffett has been going somewhere else. In fact, the legendary investor added huge amounts of this stock to his company's portfolio in the second quarter. [Read: Buffett Bets Big on Health-Care with a Huge Buy ]

Johnson & Johnson ( JNJ )
is the world's largest and most diverse health care company. This New Jersey-based giant has operated for more than 120 years in the research and development, manufacture and sale of health care products through more than 250 operating companies located in 60 countries around the world. The company generated $62 billion in revenue in 2009.

But, J&J isn't just a pharmaceutical company. In addition to being geographically diverse, J&J is a world leader in three different health care segments: pharmaceutical, consumer and medical devices and diagnostics. The pharmaceutical segment has several leading drugs including the rheumatoid arthritis drug Remicade. The consumer products division includes household staples such as Listerine, Carefree and Tylenol.

So, why did Buffett buy it now? And why should you buy it now?

It's cheap. The stock is near its 52-week low and trades at just about 12 times earnings , compared to its five-year average multiple of about 16. In addition, J&J's stock currently yields 3.7%. While the short term direction of the market is always uncertain, J&J enables investors to earn quarterly dividends while waiting for one of the world's best companies to rebound from its lows. Meanwhile, a three-year CD is paying about 1.8%.

However, the stock is beaten up for a reason. J&J has had 11 product recalls in its consumer division in the past year. Products such as children's Tylenol, Acuvue contact lenses (overseas), and hip replacement products associated with the company's Mcneil consumer healthcare unit have been recalled for an estimated cost of $600 million in 2010 alone. As a result, J&J lowered its full year 2010 earnings per share guidance by 3% from $4.75 per share to $4.65 per share.

However, with revenue of $62 billion last year, the company can afford the cost of those product recalls, and the consumer products segment will likely gain traction again in 2011. Despite the recalls, lower U.S. and consumer product sales were more than offset by higher international sales in the first half of 2010 and total sales increased +2.3% compared to a year ago. Cost cuts have led to higher net income as well, and earnings per share increased more than +18% in the first half of 2010 to $2.85 per share.

J&J right now is a perfect example of buying a good company cheap. The best time to buy a company of J&J's caliber is when investors shy away and valuations are cheap. The stock underperformed the overall market in 2009 when investors favored more aggressive stocks on the rebound from the Armageddon lows of the financial crisis. This year, the recalls have kept many investors away. But the longer term potential of the company is solid for several reasons.

Defensive industry

While many predict the pace of economic growth in the United States will remain subdued in the years ahead, noncyclical industries such as health care should be a good place to invest. After all, people still buy band-aids and aspirin even when the economy is in the dumps. J&J is also geographically diversified, with half of 2009 sales coming from outside the United States.

Huge growth trends
Worldwide demographic trends will make health care one of the fastest growing industries in the years ahead. Older people require more health care than any other segment of society, and they are getting more numerous and will represent a greater percentage of the population than ever before.

In fact, the fastest-growing segment of the world's population is 65 and older. In the United States, the "baby boomer" generation is just beginning to hit retirement age. Citizens aged 65 and older are expected to comprise 20% of the population by 2030, or one out of five citizens. In addition, as developing nations become wealthier, their large populations will demand more and better health care. About 10% of 2009 sales were generated in the fast growing Asia Pacific and African regions.

One of a kind company
J&J is the world's largest and most diversified health care company and the epitome of a blue chip stock. Here are a few reasons to like the company:

Action to Take --> Bonds might still be the best place to be in the months ahead, but over the longer term, investors should take a page out of Warren Buffett's book. J&J is one of the world's best companies and is in a prime position for the years to come. Investors looking for a solid value play should consider snapping J&J up while it's still out of favor instead of chasing the tail end of the bond bubble.


-- Tom Hutchinson

Tom has a 15-year history as a financial advisor with UBS constructing investment portfolios. Tom's background includes a NASD Series 7 and 63 certifications...  Read more...

Disclosure: Neither Tom Hutchinson nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

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