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.


     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.


     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,

*CUSIP 478160AZ7
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