Sold Cash Secured Put + Investment Thesis – Johnson & Johnson (JNJ) – $125.00 strike – April 20 Expiration

This trade was actually executed Tuesday 03/20/18. I didn’t get a chance to write about it until today.

Please visit the core philosophies article on my investment thesis process for a deeper explanation of the components of this article. Additionally you might find my rules for trading options helpful in understanding the parameters of the trade.

In case you missed it, I’m making it a point to twitter all my trades as they happen and this was no exception.

I have updated the portfolio and income tracker pages to reflect this position.

Dividend Cycle

JNJ last went ex-div a month ago on Feb26, so we’ll have another month to go after this contract expires (will I be able to squeeze in another one if this contract goes unassigned? Time will tell!)

That February dividend (which was actually paid in March) was $0.84/share, which has been the distribution for a whole year now. JNJ has raised their dividend for 55 consecutive years (making them a dividend champion and king), so it is not so much a question of if it’s time for a raise but rather how much will the raise be.

The premium collected is 1.5X the current distribution and is in force for a month.

Investment

# contracts

Strike

Expiration

Total Premium

Days in Force

Annualized Return

Closing Price

Downside Protection

1

$125

4/20/18

$126.21

31

11.89%

$131.21

4.73%

The QC (Quantitative Case)

Payout Ratio – EPS, FCF

57.0%, 49.5%

10 Year Revenue CAGR

1.99%

10 Year EPS CAGR (5 Year EPS CAGR)

3.3%

5 Year ave P/E – Current P/E (ttm)

2.69% – 2.56% = +0.13%

5 Year ave Yield – Current Yield  

24.6 – 24.3 = +0.3

10 year mean DGR (dividend growth rate)

7.4%

Debt/Market Cap

$34.59B/$351.94B (9.8%)

Total Cash

$18.3B

Return on Assets

8.25%

Return on Equity

1.99%

Profit Margin

1.70%

EBITDA/Revenue

$25.35B/$76.45B = 33.16%

Reverse DDM Fair Value DGR at Strike

7.32%

Assumed DGR (DDM valuation 10% disc.)

7.5% ($134.40)

DGR Margin of Safety

0.18%

Dividend Cushion Ratio (7.44% DGR)

1.302

Cash from Ops “cushion”

-15.70%

Capex “cushion”

+102.81%

DGR “cushion” (delta)

+9.0%

SPL (Strike Price Logic)

JNJ is a big, stable, blue-chip pharmaceutical company, which means that, relative to a lot of other stocks, it has pretty low volatility. I check the options  market every now and then, and there’s usually plenty of activity, it’s just all at a lower premium than I’m willing to accept.

Even with this trade I was a bit below my rule of 12% annualized. But $125 is a nice round number and the downside protection is fairly decent, so I went for it. I’d really prefer a 3% yield, but JNJ is a premium name…one doesn’t usually get premium names at bargain basement prices does one?

QWaF (Qualitative Warm and Fuzzy)

You may be surprised to learn that I already wrote up a JNJ investment thesis in September of 2015 when Mrs. Wizard was looking for ideas for her ROTH IRA investments. Here was the QWaF I came up with then, and some of the statistics have shifted around a bit, but not too much. I’m going to go ahead and just reuse it.

53 consecutive years of dividend increases. And….mic drop.

Seriously, you need a warm and fuzzy for Johnson and Johnson? Their shampoo is a no-tears shampoo, how much warmer and fuzzier can you get than no-tears shampoo?

They sell pharmaceuticals too. OTC and prescription…40% of sales is from pharmaceuticals. Band-Aids, Listerine, and the consumer product lines we’re all so familiar with actually only make up 20% of sales. Did you know that the other 40% of their revenue comes from medical devices? That’s a nice balance: 40% pharma, 40% medical devices, 20% consumer products. 20% of $71B is still over $14B…that’s a lot of Band-Aids, and no one else has nearly as efficient of a supply chain or distribution network. No matter how you cut it JNJ is a health care powerhouse with $34B in cash. If it isn’t in the pipeline, they can buy it. Talk about a wide moat…

CPR (Cold and Prickly Risks)

Same as above.

They’ve had a couple of oopsies with some of their pharmaceuticals and medical devices that are going to have ongoing legal costs. Don’t get me started on tort reform in this country and how much the litigious nature of this country contributes to the exponential increase in health care costs. Said exponential increase is a powerful motivator for politicians to try to “do something” which is code for “probably bad for capitalism” but still good for lawyers. Reimbursements from government doles are probably not going to just go up with whatever price companies decide they want to charge for live saving drugs. But margins are starting out high, and can you really put a price on human health? Fortunately no one single product dominates sales, so it will take more than a lawsuit or politician or two to sink this big of a ship.

They don’t have much in the way of blockbuster pharmaceuticals in their pipeline. That’s what $34B in cash is good for.

Consumer products (only 20% of revenue) face currency headwinds in international markets and possibly some weakening in “brand name” at home. Whatever. Have you ever heard of acetaminophen? Diphenhydramine HCL?

No?

Tylenol? Benadryl?

I thought so.

 

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