Monday, July 25, 2011

Stocks or Bonds: JNJ a study!

logo Johnson and JohnsonImage via Wikipedia
JNJ bond or stock – the income investor’s dilemma!


                With all the economic problems facing the world, visiting this subject is appropriate.  Are bonds safer than stocks?  Should retired people, a major category of income investors buy a bond or a stock?  Are we going to have a financial meltdown that would make you want to own only cash which generates no income?  The Gold and Silver stuff is hard to eat and what a pain to make change.

What is an income investor to do?


           Johnson & Johnson, a company known to all investors, and one of my dividend machines, is an interesting study of whether to buy the stock of a great company or to lend it money … better known as buying their bonds. Our risk is that JNJ will go out of business in the next 10 years. I doubt that JNJ will go out of business.  With that risk very low, should we buy the bond or the stock. It used to be that a bond was a safer investment than stock because when a company actually did go out of business the bondholders got money before the stockholders.   But today things are different.  Look at General Motors; this is the only company in my entire investment career that defaulted on a bond that I owned.
Should we buy a JNJ bond or should we buy JNJ stock.  To follow is an analysis for ordinary investors who want to engage in simple income investing.

JNJ BOND*

     You can lend your money to Johnson & Johnson for a little less than ten years and JNJ will pay you a yield of 3.55% every year until the note matures on May 15, 2021.  This note (a bond) is AAA rated.  If you purchase these notes, you will receive $1,000 per note when they mature.  If you bought 10 notes, you will receive $10,000 on May 15, 2011.  Because JNJ is such a quality company, you have to pay a premium to buy their debt and the cost to you for the 10 notes will be $10,392. JNJ will pay you $335 a year for a total income, every year, of $355.

     The yield percent on your $10,392 is 3.434%.  The price of this note can go up and down during the 10 years you own it.  Just during 2011, the value of this note decreased to about $9,825 in May 2011.  I wish I had bought it at that time as I could sell the note today at $10,392 and that alone would be a 5.77 % capital gain in just a little over 2 months plus the interest income. Today it traded at the high.

     But the subject of this post is not bond trading it is simple income investing.  As an income investor  I really only care that I receive $355 per year and that in 10 years I will have $10,000 to buy my next income investment.  I know that in 10 years I will need to replace my $355 per year with more income because even in a bad economy things do not seem to get cheaper.  Therefore, I need that $10,000 to generate about $500 per year 10 years from now.

JNJ STOCK

     Now let’s look at how we might fare by purchasing Johnson & Johnson stock.  If you purchase $10,392 worth of JNJ stock at the closing price today of $66.25 per share, you will own 156 shares.  Your dividend will be $2.28 per share for an annual income of $355.  Right now that seems pretty comparable to the bond.

     Using history as a guide, over the past 10 years, JNJ’s stock price has increased from $54.10 to the current price of $66.25.  You would have suffered a 10 percent loss in value in November or 2003 when the stock hit a low of $49.30; and a gain of 30% when the stock hit $70.43 in August of 2008; and they call JNJ boring.

     The question at hand is “in 10 years will my investment in JNJ stock pay me $500 per year.”  Well in 2001, JNJ paid $.72 per share in dividends and has increased the dividend payout every year with a current payout of $2.28 per share.  Therefore, you have both capital gains and income gains. Using that same math in 10 years, we hope to receive $5.70 per share or $868.92. 

           Which option gives me, the income investor, an opportunity to increase my income every year and maybe even realize a capital gain that provides me with the opportunity to buy an income instrument that makes me more income? I think it is obvious that buying JNJ stock is better for the income investor than buying the JNJ note.

           The old rule that you should hold a lot bonds when you need investment income, which usually means when you are older, is bunk…at least for now.   I have lived through more than thirty years of investing and I can tell you the bond will someday again provide a decent living  but now is not the time for income investors to buy bonds.

Very Truly Yours,
TheMoneyMadam

*CUSIP 478160AZ7
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