Last week, I shared the background and overall asset allocation for my recently introduced “Conservative Growth/Balanced Model Portfolio”. You can refer back to the article or visit my website to learn more. As I stated in the previous article, the equity component of the portfolio is overweight relative to the S&P 500 in the Industrial, Consumer Discretionary and Financial Sectors. I previously shared my basis for taking these exposures.
Last week, I reviewed my selection of an Energy stock, Chevron (CVX) that qualified for inclusion and then my reasons for including three Industrials: Administaff (ASF), Carlisle Companies (CSL), and Illinois Tool Works (ITW). This week, I addressed another "overweight" sector, Consumer Discretionary, where we started the model with positions in Bed Bath Beyond (BBBY), Columbia Sportswear (COLM) and Lowe's (LOW). Today, I would like to review my selection in Consumer Staples, Walgreens (WAG), and in Healthcare, Johnson & Johnson (JNJ).
WAG has gone nowhere for the past decade, as its inflated PE and rapid growth have both fallen dramatically. Now, the valuation is the lowest since 1994, and the company has recently dialed back its real estate strategy. I have been encouraged by its deepening moves into the healthcare services - some readers might recall that they purchased an infusion company in which I had invested, Option Care, which increased their exposure to biotech growth. They have been involved in retail clinics and mail order/PBM servces as well. The stock trades at 3X tangible book value and has a very strong balance sheet, with a net debt to capital ratio of 5%. The dividend yield is 1.36%, and their record of 26 consecutive annual increases seems likely to continue given their recently announced change in their real estate strategy.
JNJ stands out from the other investments in the model portfolio, as it has soundly beaten the market over the past year. In fact, it is the only stock that I included in the just-launched model that is up so far in 2008. The average stock is down about 12%, which is less than the 16% decline by the S&P 500. Despite my concerns that I am chasing momentum, I think that JNJ will continue to work. Technically, the stock has been consolidating a very long bull move with an ascending continuation triangle (constant resistance, rising support) that has been in place for over three years ago. It recently made a 52-week high and is close to an all-time high. The valuation is at the lowest level since 1994. Unlike many of its peers, JNJ, with its very balanced and diversified business model, faces limited risks. It derives less than 1/2 its profits from Pharma, as Medical Devices accounts for 40+% and Consumer Products another 10%. Its two largest drugs account for just 11% of sales. The company doesn't share the negative dynamic of patent expirations with its other Big Pharma peers. With a 2.7% dividend that has been raised every year for over the past 35 years and a very strong balance sheet (just $300mm net debt), the company should enjoy a bit of PE multiple expansion as well as continued above-market growth.
So, while the model portfolio is underweight both of these sectors, the individual securities stand out for their high-quality balance sheets, strong brands and extremely low valuations. WAG hasn't been working so well, but it looks to have put in a bottom. JNJ, on the other hand, has been a great stock, but it looks to have the potential to continue to beat the market.
Disclosure: No positions in JNJ or WAG