January 17, 2025
Johnson & Johnson (NYSE:JNJ) has had a rough three months with its share price down 11%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Johnson & Johnson's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for Johnson & Johnson
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Johnson & Johnson is:
21% = US$15b ÷ US$70b (Based on the trailing twelve months to September 2024).
The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.21 in profit.
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
To begin with, Johnson & Johnson seems to have a respectable ROE. Even when compared to the industry average of 20% the company's ROE looks quite decent. However, we are curious as to how Johnson & Johnson's decent returns still resulted in flat growth for Johnson & Johnson in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
We then compared Johnson & Johnson's net income growth with the industry and found that the company's growth figure is a bit less than the average industry growth rate of 1.2% in the same 5-year period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is JNJ worth today? The intrinsic value infographic in our free research report helps visualize whether JNJ is currently mispriced by the market.
The high three-year median payout ratio of 71% (meaning, the company retains only 29% of profits) for Johnson & Johnson suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.
Additionally, Johnson & Johnson has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 51% over the next three years. As a result, the expected drop in Johnson & Johnson's payout ratio explains the anticipated rise in the company's future ROE to 32%, over the same period.
In total, it does look like Johnson & Johnson has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. 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. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals?
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This article by Simply Wall St is general in nature.
We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice.
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.
