Let's begin with a ten year operation history for Johnson & Johnson:
The company has a long history of double digit growth, with sales growing annually over the last 10 years at 10.5%, and operating income at an even faster 11.95%. It generates tons of free cash flow that is really "free". It has a great position in the worldwide health market, meaning it can benefit from the falling US dollar. Finally, it is a 4 trillion dollar per year industry which is bound to keep growing.
But can we show it is cheap? I think you can if you look at the breakdown of their businesses:
(*these are operating incomes)
There are three segments: Consumer, Medical Devices, and Pharmaceutical. The first two are solid businesses with great brands. For example, the Consumer brands include Band-Aid, Listerine, Neutrogena, Aveeno, and Nicorette. And 80% of the Medical Division's products are number 1 or 2 in their markets. These are also stable and consistently growing businesses:
Then you have the Pharmaceutical business, with 2007 Operating Income of $6.5 billion. My understanding is this industry has been heavily discounted because analysts have become nervous about expiring patents and the limited possibilities for new breakthrough drugs. Now, I don't claim to have any insight or expertise with regards to their actual drug pipeline. But I do know that of the company's 2007 Research & Development expenses of $7.7 billion, $5.3 billion was for the Pharmaceuticals segment. So, if you applied a rich multiple to the company's Consumer and Medical divisions, and then assume that the Pharmaceutical business stopped research and was simply "ran-off", then you can likely justify Johnson and Johnson's current price. ( 185 billion) And their Pharmaceutical business, with its large resources and the abundance of human capital in its employees, is likely worth much more than a "run-off" type scenario.