This Stock Could Be the Perfect Defensive Play for an Uncertain Market

September 12, 2016
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I think it’s safe to say market sentiment is not particularly positive these days. Billionaire investor Ken Fisher says this is the “most joyless” bull market ever seen, while my research has been warning for some time that we are headed for a market correction… or worse.

When investors are worried about a sell-off, and even when stocks begin to correct, they flock to defensive sectors such as consumer staples and utilities. The companies in these sectors provide the goods and services people need whether we are in an economic boom or a recession.

Most defensive names also distribute dividends, allowing investors to park money in shares and collect a check even though growth may not be stellar.

These qualities make defensive stocks less prone to volatility and dramatic sell-offs than your average stock in sectors like tech or consumer discretionary.

The trade-off, of course, is that defensive names may offer less appreciation during bull runs.

In this uncertain market, a play on a defensive name is just what the doctor ordered.

Now, that doesn’t mean we should pile into just any consumer staple or utility stock. Even though these sectors are likely to gain favor during a pullback, it is important the defensive stocks we choose also be a good value.

A Best-in-Breed Defensive Stock

Not only is Johnson & Johnson (NYSE: JNJ) a classic defensive name, but the stock looks undervalued and has a secret weapon in its pocket…

The company is best-known as the maker of Band-Aids, Neutrogena, Listerine, Tylenol and countless other popular brands. It manufactures products that consumers need regardless of what they think about the stock market or the economy.

JNJ has a huge $325 billion-plus market cap and is a member of the venerable blue-chip Dow 30. Just like large ships in choppy waters, large companies tend to be more stable during rocky times.

With regard to value, Johnson & Johnson trades at a nearly 10% discount to the S&P 500′s price-to-earnings (P/E) ratio, yet the company saw adjusted earnings grow 1.8% year over year in Q2. Meanwhile, blended earnings for the S&P 500 fell 3.2%, according to FactSet — the fifth consecutive quarter of contraction.

For the current quarter, analysts project Johnson & Johnson’s earnings will increase 10.7%, while earnings for the S&P 500 index are expected to decline 2.8%.

Despite JNJ’s strong overall fundamentals, the stock is trading nearly 7% below the consensus 12-month price target of $128.18.

I think it’s safe to say that the average investor is attracted to JNJ because they know the company’s products and find comfort in its timeless brands. What many do not know is that the vast majority of the company’s revenue is not generated from these popular products. In fact, less than 20% of Johnson & Johnson’s sales came from the consumer market last year.

What’s Hidden Behind That Trusted Logo

Not only is JNJ the world’s sixth-largest consumer health company, it also runs the world’s most comprehensive medical devices business, as well as the world’s sixth-largest biologics enterprise and the fifth-largest pharmaceuticals company.

As global health care coverage improves, and as Johnson & Johnson’s promising pipeline of drugs and devices comes to fruition, these segments are set to be huge profit drivers. And this is where the upside surprise for the stock lies in my opinion.

While the defensive lure of the consumer products side should keep investors flocking to JNJ during rough market patches, growth in the pharmaceutical and medical devices segments could be the real catalyst to propel shares higher.

Pharmaceutical sales accounted for roughly 45% of JNJ’s revenue in 2015, increasing 7% year over year.

While some pharmaceutical companies have just one or two drugs that account for most of their revenue, JNJ has a diversified drug portfolio that should help reduce risk. The company has a suite of 14 drugs, with nine of those drugs seeing double-digit sales growth in the most recent quarter.

The company also has several promising drugs in its pipeline, including a cutting-edge hepatitis C (HCV) drug currently in Phase 2 trials and an expected launch date in 2020 or before.

This drug could have a shorter treatment period than Gilead Sciences’ (NASDAQ: GILD) ridiculously expensive HCV treatment Sovaldi. Given the potential cost savings, and with the hepatitis C market projected to reach $28 billion a year by 2021, this drug has huge potential.

Johnson & Johnson’s medical devices segment accounted for 36% of 2015 sales and includes cardiovascular care, diabetes care, orthopedics, surgical care and vision care franchises.

While growth in this division has lagged that of the pharmaceutical and consumer products segments, Bloomberg noted that Johnson & Johnson’s pre-tax margin widened to 31.4% last year from 28.5% in 2014, driven by an expansion in its medical devices margin to 35.6% from 32%.

And the company is working to make this segment a source of growth again. Early this year, management announced restructuring plans for the medical devices segment aimed at saving the company $800 million to $1 billion (pre-tax). The head of the division also said that the pipeline of products set to be filed by 2018 have the potential to generate combined sales of more than $6 billion.

JNJ Should Have No Trouble Holding Support

While this may not be the sexiest trade on the surface, as Warren Buffett says, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

Johnson & Johnson is a wonderful company that’s firing on all cylinders and is trading for a good value.

The masses should continue buying this blue chip for its defensive properties and solid dividend. (The company has increased its payout every year for the past 50 years, and shares currently yield 2.7%.) Meanwhile, well-informed investors should continue buying shares to take advantage of the potential profit windfalls from the pharmaceutical and medical devices segments.

Given the increasingly bearish sentiment toward the current market rally, I’d say Johnson & Johnson is the perfect defensive play.

And while you could simply buy shares and sleep well at night owning them, I recently told a small group of traders about a way to make a double-digit profit in less than two months even if shares don’t budge an inch.

All JNJ has to do is stay above $115 — a key support level going back to May. This gives us a nearly 4% downside cushion from current prices if the market does take a turn for the worse.

– Jared Levy

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