JNJ Stock: Johnson & Johnson’s Stock Buyback Raises Red Flag

 JNJ-StockInvestors Should Be Skeptical of Johnson & Johnson’s Stock Buyback

Johnson & Johnson (NYSE:JNJ), the giant healthcare conglomerate, announced this morning another round of stock buybacks worth $10.0 billion. The company is touted to have “consistently returned value” to investors in the form of dividends and stock repurchases.

The supposed “positive” news of buybacks was, however, offset by the negative news of the company’s third-quarter earnings. JNJ’s third-quarter earnings per share (EPS) stood at $1.20, down from $1.66 in the same quarter last year. JNJ stock has oscillated up and down from its opening price in Tuesday’s intraday trading, likely reflecting market’s confusion.

Johnson & Johnson is one of the many blue-chip S&P 500 companies that have announced stock buybacks this year. Interestingly, this year, S&P 500 companies have returned more money to stockholders in the form of stock repurchases and dividends than they have earned.

Historically, companies have used buyback programs to prop up share prices. The phenomenon of buybacks exceeding earnings was seen back in 2008’s Great Recession, when corporations struggled with sliding margins. This year again, investors are forewarned of an impending stock market crash, courtesy of deteriorating financials among other things.

Here’s Why Johnson & Johnson’s Stock Buyback Is a Bad Idea

During the bull market that followed the 2009 recovery, it made sense to feel optimistic about a stock buyback announcement when companies were posting strong margins. However, with JNJ’s sliding margins this year, it makes little sense why the company would announce a buyback program that, too, almost doubled in value over last year. What’s even more alarming is that the company plans to finance the buyback program with debt and not cash, which is going to further add to its debt-laden balance. The move will likely hurt loyal investors’ confidence in JNJ’s future performance, since the current low interest rates have encouraged many low-performing companies to likewise borrow at low rates to finance share repurchases in order to artificially boost stock prices.

JNJ Chief Alex Gorsky, announced the buyback program this morning, saying that the current JNJ stock price provides the company with an “attractive investment opportunity.” Now, buybacks create an illusion that the stocks were undervalued; hence, the company decided to buy them back, ignoring the fact that, had the company expected to generate more earnings by retaining cash, it wouldn’t be buying back its shares in the first place.

So in a true sense, the buyback program is not really an “investment” opportunity as Gorsky claims, since it’s not really creating any fundamental value for investors. All it is going to do is inflate the EPS figure by decreasing the divisor, creating an illusion of improved performance in the future.

It’s noteworthy that two years ago, the company decided to revamp its executive compensation structure under which the CEO’s compensation was revised down, but he is now required to hold JNJ stock six times his base pay.

It is not unusual for companies to use buybacks to reward executives by repurchasing shares at higher prices. Stock buybacks also allow insiders to exercise stock options by not diluting the shares afloat in the market, thus protecting the stock price from dropping. JNJ has a history of issuing more and more stock options to insiders, while using stock buybacks to keep the number of outstanding shares at averaged-out levels.

Here’s the Bottom Line on JNJ’s Stock Buyback

The bottom line: artificially inflated EPS is not really an “investment.” Investors should take Johnson & Johnson’s stock buyback program with a grain of salt. The move is indicative of the looming earnings troubles ahead.

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