Motley Fool Hidden Gems Investing - A Boring Business Beating the Market

Episode Date: July 19, 2022

Johnson & Johnson raises full-year guidance after delivering 3rd-quarter results. (0:22) Jason Moser discusses: - Highlights from JNJ's medical device and consumer health divisions - The spinoff of consumer health coming in late 2023 - How investors can find dividend-payers to add to their portfolio Relevant links to today's episode: Dividend Aristocrats - https://www.fool.com/investing/stock-market/types-of-stocks/dividend-stocks/dividend-aristocrats/ Dividend Kings - https://www.fool.com/investing/stock-market/types-of-stocks/dividend-stocks/dividend-kings/ (13:20) Robert Brokamp talks David Blanchett, head of retirement research at PGIM, about the 4% rule and a common misconception about retirement spending. Stocks mentioned: JNJ Host: Chris Hill Guests: Jason Moser, Robert Brokamp, David Blanchett Producer: Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

Chris Hill. For the second week in a row, we've got a dividend king that's raising guidance. Motley Fool Money starts now. I'm Chris Hill and I'm joined once again today by Motley Fool Senior Analyst, Jason Moser. Thanks for being here. Jason Moser. Well, thanks for having me back. Coming out of the bullpen. You got to be ready for that stuff, Chris. Absolutely. You got to be ready in life, in investing. Let's talk Johnson & Johnson. Third quarter adjusted profits were higher than expected. Their revenue was a little light. They raised full-year guidance.

Shares of Johnson & Johnson are down 1%, although you back it out and you look at how Johnson & Johnson has done year-to-date. It's basically flat year-to-date, which means it is outperforming the S&P 500 by about 18%. Yeah, I was going to refer that. It has been a good performer this year, up a couple of percent versus a market that, well, as you said, Chris, it's down big. You look at a business like Johnson & Johnson, I think for most of the time, people will view this as a stay boring, slow-growing business, and in a growth world, why would you own this? These times are really why you would own a business like this. This is the type of business that you would want to own just for long periods of time. I say that because

when you stretch out the timeline there and you look at how the stock has performed, any year-to- year metric, it may not necessarily hold up against the S&P. You stretch it out 10 years, for example, this is a company that has outperformed the S&P by about 44% over the last 10 years when you include dividends in the mix there. Dividends matter. In April, they raised their dividend again for the 60th consecutive year. This is beyond dividend aristocrat, this is a dividend king. As I've said before, this is one of those businesses where the longer you own it, the more sense it makes. In looking at the results, it was a strong quarter looking at sales and earnings per share growth of 8% and 8.5% respectively, that's excluding currency effects.

As you said, raising guidance, they're calling for top-line growth for the full year of 7% percent in earnings per share at the midpoint of around $10.70. That put shares today at around 16 or so times full-year estimates, not a terribly expensive multiple for such a solid performer as this. I think the big story with Johnson & Johnson, we talked about this, is just the fact that they're going to be splitting this business up. It seems like they had that blueprint fairly fairly well laid out there. I mean, you're going to see the consumer health side of the business split off, and you'll see the pharmaceutical and medtech side of the business remain as a combined entity, and that'll be the Johnson & Johnson side. It doesn't sound like they

have a name yet for that consumer health business. So, hey, listen, maybe we devote a show one day to just coming up with some ideas for them. To help them out. It could be fun, right? Yeah, drop us an email, podcastatfool.com. pass it along to the folks at Johnson & Johnson. A couple of things I want to touch on that you just mentioned. First is, and this is something our friend and colleague Ron Gross talks about from time to time, the total return of a stock, not just what is the stock doing in terms of its performance. If it is a dividend payer, you have to factor that, you should factor that in. You're right, when you look at a five-year chart of Johnson & Johnson, it doesn't look very

exciting. But when you add in the dividends and the fact that they've been doing this for well over 50 years, it's all the more impressive. This is a business that for various points in its history of the 21st century, Johnson & Johnson has been a business that will come out with their quarterly report, and you can always count on one division just not really doing well, sort of dragging down the rest of the business. It seems like they are past that, the medical devices are coming back when you dig into this report. As you mentioned, the consumer health looked good. Why do you think it's taking so long? I realize this is a question born out of, in part, my impatience, but is it just the size and scope of Johnson & Johnson that it is going

to take them nearly two years to execute, from the time they announced it to the time that it actually happened. It's going to be nearly two years, Jason, before they spin off the consumer health business. Yeah. They are aiming for sometime in 2023, so it is something that will take a little while. That's a good question. You think about that. Buying a home, for example, for consumers seems like it takes a lot longer than it really should. But then when you go through the process, you realize how many I's need to be dotted, how many T's need to be crossed. And so, I can only imagine that when you're talking in the context of a $90 billion revenue business, that's going to be multiplied. There's just going to be a lot of moving parts here that

they need to make sure they execute correctly. It's also worth remembering, and I'm glad you me that point there in regard to three segments of the business, because in the consumer health, pharmaceutical, and medtech sides of the business, they all perform very well. The pharmaceutical really was the standout with sales up 12.3%. But I think something worth remembering is that, particularly with a business like this, it's been around for so long, and it has three sides of the business, so to speak, that really play pivotal roles in their respective markets. Unfortunately, litigation comes with that. They are in the middle of some litigation that they're dealing with on the consumer health side of the business. I think there's the talcum powder issues that they have

yet to resolve. Obviously, still some issues there on the pharmaceutical side. There's just a lot of stuff that ultimately needs to be tightened up before they can really let these businesses go their respective ways, but it does feel like it's just a matter of when, not if. They remain very committed to it. Further, it does feel like they have some relatively well-laid plans for these businesses to continue to succeed. Three priorities. CEO Joaquin Duato has been only in the position for just a short period of time. He laid out the priorities there on the call here earlier in regard to the business in focusing on three primary things in order to keep this business going and growing. One is to continue to advance the pharmaceutical

pipeline. Number two, strengthen the performance in MedTech. I'll tell you what is really impressive with this business. You look at their MedTech segment, currently 11 MedTech platforms each deliver over $1 billion in revenue annually. It sounds like from what they were talking about on the call, they continue to gain share in all of these. It's a very relevant business in regard to the MedTech side of things as well. Then with the separation, that being really the third priority in separating the consumer health side of the business from the other two sides, and as I mentioned, on track for completion in 2023. It's such a a large business and it has so many moving parts and it has such a long history. They're

just some legacy issues that come with splitting anything like this off. I think what's going to be really interesting and something to follow is how it maintains that dividend reputation going forward. That's a big question for me because as it stands today, this combined Entity yields 2.6% dividend annually, which is great. Dividend king, 60 consecutive years. They are splitting off really the smaller side of the business in the consumer health. The two bigger parts of the business are going to remain intact as the Johnson & Johnson brand. I'm interested to see how they approach that dividend philosophy going forward with both businesses, but in particular, the Johnson & Johnson side, because it feels like the dividend king status,

you don't want to let that go. It's one of the reasons I fully plan on holding my shares of Johnson & Johnson that I own through the spinoff in late 2023 to see where that dividend goes. I haven't seen anything thus far because of how well the business has performed year after year for at least the past, I would call it, six or seven years. I haven't seen anything thus far that makes me think, okay, as soon as they split off, I'm dumping my shares of that one part of the business. Right now, I feel pretty confident about all three. I think you're justified in that confidence. When I mentioned the performance there in MedTech, the 11 platforms delivering over $1 billion in revenue annually each,

each. The consumer division is no slouch either, Chris. They have four brands alone that generate more than $1 billion in annual sales. The consumer division is the smaller of the three, but it's extremely relevant when you think about it. When you go to a grocery store, a drugstore, you're just running into these brands every day and chances are you have a slew of them in your house already. To your point, don't mistake the consumer division being the smaller of the three for being a lagger, because I think they are three very strong businesses on their own. You've said recently you are interested in building out the dividend part of your own personal portfolio. For people who are

looking to do the same, should they just start with a list of dividend aristocrats and go from there? How do you think about building it out? Because you could do worse than just, sort of, if nothing else, it immediately narrows the universe of stocks you're looking at. Well, there's no doubt that's the case. I think you could look at it one of two ways. You can either go just the ETF route and find an ETF that gives you plenty of dividend exposure. I mean, there are all sorts of ideas out there. But I think, to your point, that's a great way to start. Just Google dividend aristocrats, you will immediately find that list of all of the companies that qualify there, you can Google Dividend Kings and find those as well. I think

the difference is that Dividend King is not necessarily a member of the S&P, but a business that's grown its dividend for, I think, at least 50 years, if I'm not mistaken. But Dividend Kings, Dividend Aristocrats, both very reputable lists to begin that search. Some of my favorite ideas are certainly part of both of those lists. I'll put a link in the show notes and save everyone the time that they would otherwise spend on Google. Jason Moser, thanks so much for being here. Thank you. We're going to talk about saving for retirement in a minute, but first, a message from our friends at BiggerPockets. Real estate investing is one of the best ways to build long-term wealth. But to be a successful investor, you need to know what

news and trends to pay attention to and what's just noise. I'm Dave Meyer, real estate investor and VP of analytics at BiggerPockets. And in my new show, On the Market, a BiggerPockets podcast presented by Fundrise, we bring you expert perspectives in a digestible format so you can make informed investing decisions. And we make it fun. I promise you, On the Market is definitely not another boring news show. Each week, I chat with a panel of experts about the latest news and trends affecting the real estate investing world. We touch on things like government policy, 3D printed houses, investing in the metaverse, and more. So join us every Monday for On The Market, the podcast designed to help you invest with confidence. Just search

On The Market in your favorite podcast app. That's On The Market. Among the more common questions people have about retirement planning are, how much should I save? Where should I put my money? Our retirement expert, Robert Brokamp, talked with David Blanchett, head of retirement research for PGM, about target date funds, the 4% rule, and a common misconception about retirement spending. Let's go through the retirement life cycle of a typical person. They get their first job, the HR folks tell them about this thing called the 401k, and then this young person has to decide how much to contribute. In your opinion, how much should someone be saving for retirement?

When you're young, the struggle is real. You've got other financial goals you've got to worry about, like paying back loans, saving for a house. I think that the eventual goal, though, to get to about a 15% total savings rate. That could include both your contributions and your employer contributions, but 15% is a really good bogey for most people. Yes. That's what we have here at The Motley Fool. Contribute 9%, Fool matches 6%, so you can hit that 50%. That definitely seems to be the thing to aim for these days. The next decision is how to invest that money. Most 401ks these days have target date funds. When you're at Morningstar, you help create custom target date funds for clients. What factors

should someone consider when deciding how much to have in and out of the market, how much to have in bonds, and maybe what kinds of stocks to invest in? I think when you're younger, target date funds are just where you should put your money. Most people aren't great investors. I think that as you age, especially as you get close to retirement, there are important questions about what is the risk of the target date fund, what is your risk capacity. But I think that for the vast majority of listeners, a target date fund is the smart, safe way to invest. So, as this person's career evolves, hopefully, they'll be getting some raises.

Sounds good, except that, according to your research, it actually can delay retirement if you basically spend the entire raise and don't sock it away. So, how much of a raise should a worker devote to increased savings? I think as much as you possibly can. I mentioned earlier that it's really hard for younger people to save, let's say, 10-plus percent of their pay. They've got a lot of other financial goals they're worried about. And so, I think what usually happens for most people is they kind of backload their retirement savings. They save more as they age. Well, there's this kind of dual problem there. As you get older,

you might hit peak earnings years. If you start to spend more and live off more, it might create an unreachable retirement goal. So, I think, you know, this was some research I did back at Morningstar. You know, if you can try to save half of your raises or somewhere around there, that would be great. And obviously, it depends upon how much the raise is when you get it. But Really look at raises as you get older as a way to catch up on retirement savings if you're behind because you were taking care of other financial goals earlier in your life cycle. Right. One of the rules of thumb you came up with is that the older you get, the more of your raise you probably should be banking.

That's right. The next big financial decision for someone who's going through a career might be if and when to buy a house. You wrote a paper entitled The Home as a Risky Asset, which I think some people would find surprising. How should someone factor in their home into their retirement or financial plan, if at all? There's this notion that owning a home is the American dream. I kind of get that. There's this idealized American picket fences, all that. I think that homes are actually really risky. This notion of a risky house didn't really exist pre-2008. Everyone thought, homes go up 3% a year. Well, there's a lot of problems

if you look at home price indexes. They're repeat sales indexes. They totally ignore capital improvements. And so, I think that for a lot of folks, renting actually makes a ton of sense. If you're younger, you're not going to create more wealth via a home. You're going to do so via your human capital, via the flexibility of working. However, as you age, the value of a home increases. And one thing that's unique about homes is they're both investment goods and consumptions goods. It is possible to make money owning a home. I think that a lot of folks that live in California have seen that. But another interesting thing that they do is they give you some place to live. In a lot of places right now, if you're renting, you're seeing your rent go up

30%, 40%, 50%. Having a home immunizes you from that risk. As you age, as you feel more secure about where you're going to be, I think owning a home can make a lot more sense. This notion that we all hold that homes are great investments really isn't true if you look at the numbers. Yeah. We've often talked about that homeownership is often oversold. In the paper, you pointed out that people think that homes go up at a rate that exceeds inflation. But when you factor in the cost of homeownership, actually, you could be losing to inflation. Right. Obviously, if you think about a lot of the expenses you incur as a homeowner, like real estate taxes, you're either going to pay them explicitly as a homeowner or implicitly

as a renter. If I'm renting an apartment somewhere, the person that owns the building is paying those taxes, I have to make that up. I just think that when people look at the case-shiller indexes, those indexes totally have no idea if someone buys a house, put a half a million dollars into it, and flips it, that's not a corporate. When you strip out all these actual expenses of homeownership, the actual return you realize can be significantly lower than commonly suggested. All right. This person's finances are getting a little bit more complicated, and they think, you know what, maybe I should get some professional help. In your work, you've attempted to estimate the value of working with a financial advisor.

Should most people work with some kind of pro? If so, what type should they look for? I think so. There's this question of, what are you going to do if you don't work with one? If you are very astute financially, if you can go online and you can read information and not react to markets, you have less need of one. you're someone that appreciates the guidance, that wants professional help, I think they can add tons of value, far more than their fees. I think that there are important questions and things to look for, though. If you're working with one, are they a fiduciary? What are their qualifications? How do they get paid? A very common model in the industry is 1% of assets.

I think that can make a ton of sense. But if you've got $1 million and you're paying someone 1% of that or $10,000 a year, understand the value you're deriving from that relationship versus, say, other models that exist, like hourly or retainer. I don't want to suggest that one is better than another. I just think that it's really important to understand, again, the value of the advice versus other alternatives out there. You did a study in 2019 that looked at how people fared relative to the sources of their financial information. You basically came down to how sales working with a financial planner did better,

then folks who got it from the internet. The folks who did worse were those who worked with a transactional advisor, like a broker or someone like that. Yeah, I think that there's been a very large transition in the industry towards fee-based services. Technically, how you're paid shouldn't matter in terms of the quality of advice. But I think that working with someone that, again, is more of a fee-based fiduciary is just a better model because it does align incentives better between the client and the advisor. Our hypothetical worker is now in their 50s, and they're starting to think about,

okay, when should I retire? Nowadays, the average retirement age is somewhere between 62 and 64. But from an individual planning perspective, and maybe even from a societal perspective, is that a reasonable target, or are we retiring too soon? The problem with retirement ages is that we fundamentally get them wrong. There's about a three-year average gap between when the person thinks they're going to retire and when they actually retire. If you look at why someone retires early, more than half of the time, it's involuntary. They got laid off and can't find more work. They have a health issue. My concern about retirement ages and financial plans is that that is one of the most important

assumptions out there. If you retire three years early, it can be devastating your overall financial scenario. One common recommendation that I put out there is, if you think you retire at 65, try to work to 68, but plan like you're going to retire at 62. That way, if you do end up retiring when you're going to on average. Three years early is the average. You're going to be okay. And then if you can prolong that as long as you can, that is fantastic. The problem is, if you aren't able to do that, it's probably not going to be your fault. You got laid off. You had a health issue. Something happened. Those are things that you just can't plan for. And so, you want to do more when you're healthy and actively working versus being caught

and retiring four years earlier than expected and have to deal with the consequences. Okay, so our hypothetical person is coming up on retirement. One of the key variables in the calculus of retirement is how much income someone needs each year. It's often referred to as the replacement rate because it's expressed as a percentage of pre-retirement income. What's a reasonable replacement rate for most people? There's this thing called the 4% rule that goes back 30 years. I think that that's fine. I think that 5% is actually fine for a lot of folks. I think what's really important that a lot of this research overlooks is what is your retirement liability? How much do you need

every year and how much do you want? So I would say my total goal is $100,000 a year. I need 50K, half of it I want 50K. If I'm getting $50,000 a year from Social Security combined, then all of my needs are covered. From that once bucket, I can probably take out 5% a year because I'm okay to cut back if I need to. Now, if for some reason none of my needs are covered with guaranteed income, maybe it's closer to 3% because I can't afford a shortfall. I think that the one thing that people don't think about when it comes to replacement rates or initial withdrawal rates is, how would a cutback affect you during retirement? A lot of the models we use, I think, aren't very good. Success rates really aren't a very descriptive

statistic when it comes to the quality of retirement outcome. One of the underlying assumptions of the 4% rule is that retirees will need withdrawals to keep up with inflation each and every year. But your research actually indicates that may not be the case. Tell us a little bit about the spending patterns of retirees and maybe how that affects a retirement plan. Sure. When you think about most financial plans, virtually every tool out there assumes that the need increases by inflation. Literally, the retiree calls up the planner and says, hey, CPI went up 4.2% last year. I need a 4.2% raise. That's not reality. But if you track retirees over time, over decades, what you see is that spending tends to decline in today's dollars

or real terms by 1% or 2% a year. So, if inflation is, say, 3% a year, maybe they spend 1% more. There are implications where later on in retirement, so if you live into your 90s, there are some folks that do see increases based upon healthcare expenses. What's important, though, is that's not the average retiree. It's like one out of four. And so, then they all of a sudden see these massive spikes in spending. But I think that this assumption that you need to increase your spending by inflation just doesn't track reality. I think that you need to ask questions about what is your consumption basket. But I think a safe assumption for most plans is that I'm going to assume that my retirement spending goal decreases by, say,

1% or 2% a year versus inflation on average. Let's touch on a potentially controversial topic, and that's annuities. I know a lot of products fall under this label, and frankly, a lot of them stink or are too expensive. But the plain vanilla single premium immediate annuity, where you hand over $100,000 to an insurance company, and then they send you $7,000 to $8,000 a year for the rest of your life. I think it makes a lot of sense. But few people actually buy them. So what's your take on whether and how much a retiree should invest in an annuity? You said the A word. I think that, to your point, it's a very controversial topic. I think that, to your point, a lot of them do stink. Let's just be honest here. But if you want your needs

covered in retirement, you don't know how long you're going to live. You know what markets are going to do. And I think an annuity can really help simplify that equation. Now, what's really important is if you want guaranteed income, the only place today you can go today and buy, quote unquote, buy a product that has a positive economic value is delaying claiming Social Security. So if you want more guaranteed income, that is the first place you go. But if, so let's say that you've done that or you can't do that, whatever, and you want more certainty, you don't like the fact that you're spending less, you don't know how long

you're going to live, annuities can be a viable option. The one that you mentioned, immediate annuities are the plain vanilla basic strategy that you just hand over a lump sum to an insurance company, they guarantee you income for life. Those make a ton of sense. They're very straightforward. They're very easy to buy. There are other more complex products out there that might be better for an individual. The problem is the complexity, the transaction costs, etc. So again, those can also make sense. But a lot of the advisors that sell those aren't necessarily fiduciaries. So if you want more guaranteed lifetime income, delay claiming Social Security, look at Aspia. And then if you want

something else, talk to an advisor, but I would focus one that's more fee-based versus transactional to ensure that the product they recommend really is in your best interest. You and Michael Finco wrote a piece called Guaranteed Income, A License to Spend. What you found is, retirees actually underspend, especially if they're just living off their portfolio, because they're concerned that they're going to outlive their money. Whereas, if you add more guaranteed income, it gives them the psychological freedom to feel comfortable spending their money, and they enjoy their retirements more. Yeah, I mean, I think retirement's kind of terrifying. The markets go down,

I could live forever. It creates this uncertainty that's hard to deal with. And how individuals deal with uncertainty is they become very conservative. They're worried. They know that, to use the word earlier, they depleted their human capital. Their only alternative, if they live a long time, is to go work at Walmart or to live off of their kids. They don't want any of that. And so, what happens is they react by being afraid and not doing things that they enjoy. I think that what can simplify retirement radically is getting that guaranteed paycheck. As long as you live, this is coming in. And again, if that's of interest to you, which I think it should be to most retirees,

allocating more of your savings away from the markets, which are uncertain, towards products and trades that provide guaranteed lifetime income can make a ton of sense. So, final question here. Looking 10 to 20 years out, what do you see changing or hope to see change about retirement planning? To your final question, I do hope that we'd see more retirees actively incorporate products that provide longevity protection. There's a whole bunch of innovation in this space, but it's really hard to deal with idiosyncratic retirement risk. I don't know how long I'm going to live. I don't know what my

returns are going to be. The more that we can get back to pulling that, the better we are as society. Defined benefit plans were awesome. The movement away from those has not helped us achieve better retirement outcomes. It makes things worse. We all have to figure this out on our own. The more that we can create strategies, products, whatever that simplifies that, the better we are as a society. I think it makes a lot of sense. David, thanks so much for joining us. Sure thing. That's all for today, but coming up tomorrow, we will dig into the latest earnings from Netflix. As always, people on the program may have interest in the stocks they talk about,

and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow. you