Retirement Strategy: A Fate Worse Than Death?

What if we live beyond our means, never plan for our later years, and have absolutely nothing but social security benefits to live on? Well to be rather blunt, we would more than likely not have a great “golden years” period. Yes, there are many people who simply do not care and whatever happens, happens. The good news here is that if you are reading this, you already have a better shot at a financially sound retirement. Now, please drag some folks you know over to Seeking Alpha to read some of my simple little articles!

What Might Happen If We Rely Solely On Social Security Benefits?

The average benefit from social security is about $1,300/month for an individual and for a couple is roughly $2,200/month. Since I have already shown what the average couple spends annually during retirement, the difference could be around $30k per year! If you have nothing else, then your simplest option is to reduce your expenses to less than your income. If you think that is an easy task in this scenario, then you are living in a fantasy world. This article gives us an idea of just how common this situation actually is:

Nine out of 10 Americans 65 and older receive Social Security benefits, and it’s often their primary source of income. Social Security was at least 50 percent of income for 52 percent of beneficiary couples and 74 percent of single beneficiaries, and at least 90 percent of income for 22 percent of couples and 45 percent of singles.

This Forbes article paints an even more dire scenario for the future:

…most Baby Boomers will be down to subsistence living by the time they are 80-living on Social Security and other government benefits with help from any capable children.

I would love to hear from our readers if you are one of those rare creatures that can make a go of it on 15-20k per year, and how you do it. It’s probably not impossible but I doubt if I MYSELF would want to be on that position.

The Limited Options

Well, as tough as it may be, there are some options that an individual can take to help squeeze by.

  • Reduce expenses to less than your SS benefit, forever (this will be a very frugal lifestyle at best).
  • Work until you are 70 1/2 to receive roughly 35% more SS income. Even if you do not live a long life, you will ALWAYS have a higher benefit, as will your spouse if they never worked.
  • Work part-time to close the gap between your expenses and income.
  • Make arrangements to live with your adult children and share your income with them to help defray their costs.

A Few “Outside The Box” Side Gigs

Those of us who are healthy and physically well enough might consider several “unique” side jobs to help boost your income.

Golf Ball Retrieval

Don’t laugh too hard, but even the US Bureau of Labor Statistics has an entire section on this “job”:

Typically, golf ball divers earn money for each ball they recover. Buyers include the golf course, retailers, and golf ball companies. Anecdotal information suggests that divers earn about $200 a day.

Image result for golf ball diving

If you like golfing and scuba diving, this just might work!

Dumpster Diving

I couldn’t find any statistics from the BLS, however, it does seem to be a popular “cult” thing to do!

…dumpster diving seems to be totally blowing up… it’s basically green’s answer to dubstep for search query volume and media references. Check out Google’s trend analysis and you can see the dumpster diving traffic spike laid out pretty clearly, with Portland, OR leading the way…

You might not make much cash, but you just might be able to subsidize your food bill! Maybe even clothing! Here is an actual article on some key “tips” for successful dumpster diving. I think if you are going to do this, you might as well do it right, don’t you?

So for those of you out there interested in saving a ton of money on food, reducing your environmental impact, or sharing a huge bounty of food with your friends and people in need I’m here to help with that.

Image result for dumpster diving

Photo Source

I am not sure about you, but I am not thrilled with this option!

Professional Dog Walker

This side gig is actually quite popular! Of course, you have to like dogs, have no allergies to them, and be prepared with plenty of “pooper-scooper” baggies! Rather than having me tell you about it, check out this article:

The benefits to opting for this type of business are clear. Dog walking for a living allows people who enjoy both the outdoors and the company of canines to combine business with pleasure.

Any initial outlay to become a professional dog walker is also reasonably small, with transport the only real material expense to those launching their business.

photo credit: Alberto Gonzales/Flickr

According to a survey conducted by the National Association of Professional Pet Sitters (NAPPS), animal caretakers charge a median rate of about $16.00 for a thirty-minute visit, which is the length of a standard dog walk.

At this rate, if you did five walks a day every weekday, your dog walker salary would be $19,000.00 per year.

Not to be outdone by dumpster diving, here is an article with 7 tips on being a great dog walker! This side gig might actually be fun!

OK, Chuckle Time Is Over, So Hopefully You Will Get Down To Business!

Of course, all of this might be considered tongue-in-cheek, and I am attempting to get a few laughs on yet another rough day, but obviously I am once again trying to get my message across that saving and investing as soon as you can, for as long as you can, just might “save” you from even THINKING about the above options.

The model Dividend King Retirement Portfolio was constructed for those of us with shorter time horizons and a lower risk tolerance level, but by no means is it a one size fits all approach, especially if you have 15+ years to go before you decide to quit the “rat race”.

The model DKRP currently consists of Coca-Cola (KO), Procter & Gamble (PG), Johnson & Johnson (JNJ), 3M (MMM), Emerson Electric (EMR), Cincinnati Financial (CINF), Lowe’s (LOW), Hormel (HRL), Colgate-Palmolive (CL), Dover (DOV), and AT&T (T).

By having a plan to invest (and re-invest) in some of the greatest companies on the planet, that have a history of paying and INCREASING their dividends for over 50+ consecutive years, you just might be giving yourself a better shot at a more secure financial future. The “secret” is to focus on income, start investing as soon as you can and keep re-investing the dividends to add more shares as time goes by.

Aside from the current market, adding shares by buying the dips will grow the portfolio exponentially. More shares mean more income. Keep in mind that due diligence is required to make sure that the companies in YOUR portfolio can continue to pay and increase their dividends. If not, then be prepared to take action and make changes in your core. Other than that, buying and holding STILL works with this approach as long as you have the risk tolerance level to ignore daily share price fluctuations.

Keep in mind that over the very long term, the markets have ALWAYS gone higher, even after the most disastrous corrections and/or bear markets:

The stocks within the portfolio are just a few of the Dividend Kings that have achieved this elite status and all of them can be found right here.

The current 2018 (updated) Dividend Kings list:

American States Water (AWR) – 63 consecutive years

Dover – 62 consecutive years

Northwest National (NWN) – 62 consecutive years

Emerson Electric – 61 consecutive years

Genuine Parts (GPC) – 61 consecutive years

Procter & Gamble – 61 consecutive years

Parker Hannifin (PH) – 61 consecutive years

3M – 59 consecutive years

Vectren (VVC) – 58 consecutive years

Cincinnati Fin. – 57 consecutive years

Johnson & Johnson – 55 consecutive years

Coca-Cola – 55 consecutive years

Lancaster Colony (LANC) – 55 consecutive years

Lowe’s – 55 consecutive years

Colgate-Palmolive – 54 consecutive years

Nordson (NASDAQ:NDSN) – 54 consecutive years

F&M Bank (OTCQX:FMBM) – 53 consecutive years

Tootsie Roll Industries (TR) – 52 consecutive years

Hormel Foods – 51 consecutive years

ABM Industries (ABM) – 50 consecutive years

California Water Services (CWT) – 50 consecutive years

Federal Realty Investment Trust (FRT) – 50 consecutive years

SJW GROUP (SJW) – 50 consecutive years

Stanley Black & Decker (SWK) – 50 consecutive years

Target (NYSE:TGT) – 50 consecutive years

I would guess that there are lots of folks who would prefer giving this approach a shot rather than dumpster diving!

But Wait, How About The Cash I Have Been Building??

Several months ago, I stated that since I am a retired old guy, I was not going to continue buying every dip and would wait for a real, steep correction that lasts longer than 24 seconds. It appears that I made the correct decision. I have not added one share of anything nor have I sold anything. As far as I am concerned, the new tax rules and corporate earnings have been strong enough for the companies I follow, but the uncertainty of almost everything else is allowing this market to sell off in such a sporadic manner that even if I had a crystal ball, it would probably freak out!

Chart

^SPX data by YCharts

From a technical standpoint, it looks like we keep testing support levels, and if you have been buying every dip, you might be running out of cash at some point. I myself am only 50% invested and I will continue to wait for a large leg down to begin adding to my shares.

That being said, the model DKRP, as well as other dividend kings, might have actually hit correction territory. What that means to me is that I will begin making a shopping list of several good buys that I will consider adding to.

Let’ take a look at where this model portfolio stands:

Chart

KO data by YCharts

As you can see from the chart above, after 6 months of craziness, there are not many stocks that are even close to true correction territory. The only one that I will be doing research on for POSSIBLY adding to the 3M position. I will let you know what I decide.

For the record, 3M is selling for about $212 share (as of 4/2/2018) and yields roughly 2.50%. The current price is below the mid-point of the 52-week high and low (188-259) and is a combination technology, industrial, and consumer product company with a very wide moat as well as a stellar balance sheet. Its funds from operations at the end of 2017 were $5.62 billion and its free cash flow was at a very healthy $4.89 billion. Strong enough to continue paying and increasing its dividend as it showed back in late January by raising its dividend by a very generous 16.2%, from $1.17/share to $1.36/share.

At the time, the yield was only 2.2%, so the drop-in share price and the increased dividend makes this a stock I would consider adding to, even in this wacko market.

All of this being said, I am STILL completely content to continue building cash while this market continues its recent gyrations. If I had 10+ years to go before I retire, then I probably would be taking small bites of each stock to grow the number of shares held and the income. Being retired and having enough of an income stream right now makes building cash and capital preservation higher priorities for me.

I continue to dislike this market as a whole, by the way. How about YOU?

The Bottom Line

Hopefully, you got a few laughs from this article, but the unfortunate truth is that without a plan, you just might face very limited options to have a more secure financial future. I will continue to keep you posted as to what I am doing with cash reserves.

***If you like this article and hope to see more like it, check the little thumbs up at the end of the article.

Not To Bore You, But…

Knowledge is power, and many folks shy away from the investing world because that very world makes it more confusing each and every day in an effort to sell you something: stock picks, technical strategies, books, videos, subscriptions with “secret ideas,” gadgets, and even snake oil.

My promise to you is that my work here will remain free to all of my followers, with the hope of giving to you some of the things that took years for me to learn myself. That being said, let me reach out to you with my usual ending:

*A Special Note About My Free Articles:

Seeking Alpha is a business, and believe it or not, they do need to make a few bucks to keep bringing you all of its amazing content at virtually no charge! To that end, Seeking Alpha will be charging some fees to access older (and remarkable) content from its extraordinary library of information, not just from me, but from all authors.

All of my articles will remain free until they are placed behind the paywall after a minimum of 10 days. Only ticker-specific articles will be placed behind a paywall, not articles such as this one! If you are a real-time follower, you will be notified immediately of any of my new (and free) articles, just as you have received in the past!

**One final note: The only favor I ask is that you click the “Follow” button, so I can grow my Seeking Alpha friendships. That is my personal blessing in doing this and how I can offer my experiences to as many regular folks as possible, who might not otherwise receive it.

Disclaimer: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him, and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance. The long positions held are based upon what the model portfolio holds, and I personally could have held all of the stocks noted at one time or another.

Disclosure: I am/we are long CINF CL DOV EMR HRL JNJ KO LOW MMM PG T ABM AWR CWT FMCB FRT LANC NORD NWN SJW SWK TR VVC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The portfolio is for educational purposes only and not an actual portfolio. The long positions are based on the model portfolios.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Walmart opens first small high-tech supermarket in China

BEIJING/NEW YORK (Reuters) – Walmart Inc has opened its first small high-tech supermarket in China, where smartphones can be used to pay for items that are mostly available on the U.S. retailer’s store on Chinese online marketplace JD.com, it said on Monday.

FILE PHOTO: Pedestrians walk past a signboard of Wal-Mart at its branch store in Beijing, China, October 15, 2015. REUTERS/Kim Kyung-Hoon/File Photo

The world’s largest retailer, known for its hypermarkets, is expanding in China as shopping with mobile devices gains popularity in the country, and as retailers and technology companies such as Alibaba Group Holding Ltd and Tencent Holdings Ltd cut deals to integrate online and offline shopping.

Walmart is also targeting more online shoppers, who spend twice as much in the United States when buying on its website.

Walmart had run smaller Walmart Express stores in the United States, with 12,000 to 15,000 square feet, compared with about 105,000 square feet for its typical supermarket. But the concept did not take off and the retailer was forced to shut them down in 2016.

Walmart did not specify the size of the China store, in the southern city of Shenzhen. The company did not immediately respond to a request for comment.

The outlet will stock more than 8,000 items ranging from stir-fried clams to fresh fruit, 90 percent of which will be available online, it said in a statement. Items can be delivered within a 2 kilometer (1.2 mile) radius as quickly as 29 minutes, said Walmart, which owns a stake in JD.com.

Customers can opt to pay with their smartphone using a program on Tencent Holding Ltd’s WeChat messaging.

In March, Walmart said it would expand its grocery home deliveries in key markets to reach more than 40 percent of U.S. households, or 100 metro areas from six currently.

Reporting by Pei Li and Brenda Goh in Beijing and Nandita Bose in New York; Editing by Muralikumar Anantharaman and Richard Chang

Best Fitness Trackers (2018): Fitbit, Suunto, Garmin, Nokia, Apple Watch

This stark, minimalist device is a hybrid between an analog watch and a smart one. It looks like an elegant fashion accessory, but connects to the Nokia Health app on your phone to show stats like your heart rate, steps, and distance traveled. It’s simple and slim, with a velvety silicone band, and can transition from surfing to a wedding brunch without skipping a beat. And, at $180, it is one of the most affordable fitness trackers out there.

Saks, Lord & Taylor hit by payment card data breach

NEW YORK (Reuters) – Hudson’s Bay Co said on Sunday that data from card payments in some of its Saks and Lord & Taylor stores in North America had been compromised.

The Lord & Taylor flagship store building is seen along Fifth Avenue in the Manhattan borough of New York City, U.S., October 24, 2017. REUTERS/Shannon Stapleton

The Canadian retail company said it had identified the issue and taken steps to contain it, adding that “there is no indication” so far that the issue had affected the company’s e-commerce or other digital platforms.

Customers will not be liable for fraudulent charges that may result from the issue, the company said.

The stores involved include Saks Fifth Avenue, Saks OFF 5TH and Lord & Taylor, the company said.

Reporting by David Henry in New York; Editing by Bill Rigby

Facebook Employees Are Reportedly Deleting Controversial Internal Messages

Facebook employees are deleting potentially controversial comments and messages from the company’s internal communications systems, after the leak of a 2016 memo in which Vice President Andrew Bosworth appeared to place growth priorities ahead of public safety concerns.

According to Facebook employees who spoke with the New York Times, staffers are also urging the company to hunt down the leakers who released the Bosworth memo.

If the report is accurate, the deletion of internal communications could have legal implications, including in an ongoing Federal Trade Commission investigation into the company’s data-handling practices. Destruction of internal documents was a partial focus of the FTC’s recent investigation of Volkswagen.

Bosworth’s memo continued catastrophic PR fallout following findings that the Facebook data of as many as 50 million users was wrongly harvested by the election consulting firm Cambridge Analytica. In the memo leaked Thursday, Bosworth wrote that “connecting people” should be the company’s driving goal, even if “it costs someone a life by exposing someone to bullies” or “someone dies in a terrorist attack coordinated on our tools.”

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Facebook executives have defended the memo as merely provocative, and not actually intended to deny Facebook’s responsibility to try to prevent bullying or terrorism. Bosworth issued a statement via Twitter Thursday night saying he “didn’t agree with [the post] even when I wrote it” and cares “deeply about how our product affects people.” He further wrote that “this was one of the most unpopular things I’ve ever written internally and the ensuing debate helped shape our tools for the better.”

While some parts of Bosworth’s message may be defensible as pot-stirring hyperbole, others are more difficult to rationalize. For instance, Bosworth wrote about “questionable contact importing practices.” That phrase shows high-level internal awareness about choices including the collection of detailed call logs from many Facebook users, which reached public attention last week. That news contributed to growing signs that users no longer trust the social network to protect their personal data.

Postmates Delivery Service Revives Dot Com Bust Era Business Niche

This article first appeared in Data Sheet, Fortune’s daily newsletter on the top tech news. Sign up here.

I’m feeling nostalgic these days. Maybe it’s because the beginning of baseball season swells my heart with all those clichéd feelings of hope springing eternal. Perhaps like skeptical journalists everywhere I can’t help but experience just a wee bit of schadenfreude over haughty technology companies at least temporarily getting their comeuppance. (Strunk and White counseled against the use of foreign languages where English suffices; I think I’m on firm ground here.) Or it could just be that I’m looking forward to spring break next week.

Three items that have fed my nostalgia.

This week I met for the first time Bastian Lehmann, the confident German-born CEO of Postmates, an on-demand delivery company. He told me the category his company has helped re-create ceased to exist when Kosmo went out of business during the first dot-com bubble. Ah, Kozmo. I remember you well. And your category mate Webvan too. Those were good times. Among the ways Postmates and its competitors are different is that their Uber-like driver/contractors don’t cost them much money. What hasn’t changed: Lehmann reports that pints of Ben & Jerry’s ice cream are a popular delivery item.

I also noted the demise of Lytro, an extravagantly funded startup that tried commercializing something called a light-field camera. In Lytro’s salad days, 2011, founder and CEO Ren Ng demonstrated the company’s product at Brainstorm Tech in Aspen, Colo. It was the runaway hit of the conference—and also, if memory serves, where Ng met Andreessen Horowitz’s Jeff Jordan, who would invest in the company. Ng told me a charming story in Aspen about how Steve Jobs had recently rung him up to ask for a demo, something Jobs was wont to do. Now the Apple founder and this once-promising startup are both gone.

Lastly, a non-technology story that nevertheless hinges on science—or at least pseudoscience. McDonald’s announced this week that its U.K. stores will phase out plastic straws, the bete noire (there I go again) of environmentalists. The very first big story I worked on, for a trade publication called Plastics News, was about McDonald’s doing away with the polystyrene “clamshell” burger container. It replaced it with a coated paper wrapper that wasn’t recyclable and didn’t keep the food as warm. I couldn’t find any of my old stories, but check out the name of the Washington Post staff writer who contributed to this article. This reference is going to make her feel nostalgic too.

* * *

In yesterday’s Data Sheet, I mistakenly included Google Ventures in the list of firms that had backed Shyp. They had not. My apologies for the error.

Smugglers Caught Using Drones to Drop $80 Million Worth of iPhones Into China

Chinese customs officers have arrested smugglers who attempted to drop millions of dollars worth of iPhones from drones into China.

Twenty-six suspects were arrested in China recently after they tried to use drones to fly two 660-foot cables from Hong Kong to Shenzhen, according to Reuters. Those cables were going to be used to lift iPhones worth 500 million yuan ($79.6 million) to the mainland, where they could be sold via the black market for a hefty profit, according to the report. A local Chinese report from the Legal Daily said it was the first time drones were employed to smuggle phones.

The operation was set to go off at night, where smugglers would pack small bags with approximately 10 iPhones and attach them to the drones. Those drones would then fly from Hong Kong to the mainland in just a matter of seconds. According to Reuters, the smugglers had the ability to transport up to 15,000 iPhones each night.

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Smuggling of high-value products—like iPhones, jewelry, and luxury products—is nothing new in China. In fact, the government has been working hard to crackdown on the practice and do a better job of breaking up what has become an increasingly powerful black market.

Smuggling gangs often steal devices or buy them at a deeply reduced rate and sell them for a higher price in China. They’re careful, however, to keep their prices below the going rate for those who purchase products legitimately. The result is a profitable business for smugglers and an opportunity for Chinese consumers to get authentic goods at a cheaper price.

Despite breaking up the drone attempt, Shenzhen officials warned that smuggling would continue. According to Reuters, the customs officers are planning to use several types of equipment to thwart other attempts by the smugglers.

No, Buffett Is Not Buying GE

Yesterday, rumors began swirling that General Electric (GE) might be of interest as a significant investment, or even as a takeover candidate, from none other than Warren Buffett’s Berkshire Hathaway (BRK.A) (BRK.B). So enthusiastic were investors that GE might finally catch a break that shares went up as much as 6.5% – no small sum that represents over half a billion in market capitalization.

Unfortunately, dreamers that bought GE are likely to be disappointed. Here’s why.

Buffett’s past with GE

Ten years ago, the Oracle of Omaha famously invested $3 billion in GE preferred stock at the height (or perhaps in the depths?) of the Great Recession. The preferred shares, superior in dividend preference to common stock but inferior to debt, came at a high price for ‘The General’: 10% interest per year in perpetuity. If GE wanted out, it could repurchase Buffett’s preferred stock at a 10% premium (which it did for a total of $4.1 billion, including dividends, in late 2011). As icing on the cake, Buffett’s Berkshire received warrants to purchase nearly 135,000 shares of GE’s stock at $22.25 per share.

If this sounds like a sweet deal for Buffett, you’re right – it borders on usurious. It’s good to be The Oracle, after all.

A struggling giant

Now, a decade later, GE is faced with a different problem. Macroeconomic storms have given away to microeconomic travails:

General Electric Selected Financial Results

FY 2015

FY 2016

FY 2017

Total Revenue

$117.4 billion

$123.7 billion

$122.09 billion

Gross Profit

$32.09 billion

$33.4 billion

$17.99 billion

SGA Expenses

$21.9 billion

$19.36 billion

$20.44 billion

Operating Income ( Loss)

$11.65 billion

$14.05 billion

($3.9 billion)

Net Income

($6.12 billion)

$8.83 billion

(5.8 billion)

Free Cash Flow

$12.58 billion

(7.44 billion)

$3 billion

Data Sources: General Electric, Scout Finance.

The winding down of GE Capital, as well as other “one-time items” has distorted GE’s net income. But, as Buffett’s teacher Benjamin Graham pointed out in The Intelligent Investor, why ignore such costs in valuing a business? Graham knew that a company of any reasonable size (and especially enterprises of GE’s scale) will ALWAYS have expenses like this crop up.

The more reliable figure for a quick-and-dirty analysis, free cash flow, is flashing an alarm bell (Fun fact: GE’s free cash flow, according to our friends at Scout Finance, came in at a whopping $15.12 billion in 2013 and a staggering $20.6 billion in FY 2014.) What a difference a few years makes.

Buffett knows this, and he will inevitably look to each division’s results for signs that the ship can be righted. Unfortunately, the prognosis here is not good:

GE Segment Revenues

Source: General Electric FY 2017 10-K.

General Electric Segment Profit

Source: General Electric FY 2017 10-K.

By shedding GE Capital, ‘The General’ was getting back to its industrial roots. Unfortunately, its industrial roots aren’t exactly growth businesses these days (save for Renewable Energy, but even that represents a small portion of the whole). Any buyout of GE means you get the whole thing – and the whole is not thriving.

John Flannery now leads the company, acknowledged to be a smart company man and touted as the man who turned around GE Healthcare. Alas, Healthcare’s performance over the past three years, the approximate period Flannery was at the helm, was not anything to write home about (see above).

Flannery seems to have the situation in hand (which unfortunately forced him to cut GE’s dividend and plan large cost cuts). The problem is that the situation is an extremely tough one and almost certainly not something Buffett would want to dive into. That is unless GE is willing to part with one of its top performing divisions, of course.

Buffett’s Cash Won’t Fix GE

Arguably, Buffett made his first millions as a distressed investor and turnaround artist. Anyone who has read just one of the numerous biographies of the man has no doubt heard the tale of Dempster Mill Manufacturing, GEICO, and even a New England textile manufacturer named Berkshire Hathaway.

But those days are over. Buffett wants to buy great businesses at fair prices – low stress is the name of the game.

Not only that but Buffett’s other well-known “opportune” investments in national brands (made at a time of distress) all had one of two characteristics: (1) The source of trouble is immediately solved with capital. The simple need for cash was the case with Buffett’s 1970s investment in GEICO when the company needed cash to survive, but the fundamental business of providing low-cost insurance to government employees remained intact. Once the capital infusion occurred, the insurance regulators backed off. Or (2), the business itself is excellent, but the company has a dark cloud over it. This was the case with Buffett’s investment in American Express (AXP) in the 1960s.

General Electric is different.

A pile of money won’t solve its woes (although that wouldn’t hurt given the company’s debt load) and most of its businesses are barely growing – if that. So, no, Buffett won’t be buying a massive stake in GE nor will be gobbling up the whole thing.

What you need to know

Buffett will not be riding in to rescue GE on a white horse.

Could I be wrong? Absolutely. Buffett has unmatched insights and access to information (how often do you suppose he and Flannery have talked in the past few months?). Combining any one of GE’s businesses with Berkshire’s could lead to significant cost savings – a potential source of upside that few possess. Or perhaps he could call up his friends over at 3G Capital for some good old fashioned zero-based budgeting magic.

But I doubt it.

It SOUNDS like the cap to a fantastic investing career. But it wouldn’t be Buffett. If anything, he’s talking to Flannery at the time of this writing about acquiring one of GE’s better performing industrial businesses. I can only hope Mr. Flannery takes a pass. The worst thing one can do in a crisis is make a deal on onerous terms, a lesson I can only hope GE learned in its previous dealings with Mr. Buffett.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Now Is The Time To Buy The 2 Best Dividend-Paying Pharma Stocks

(Source: imgflip)

My dividend growth retirement portfolio has an ambitious goal of generating 12% total returns over time. The cornerstone of my strategy is a highly diversified portfolio of quality dividend companies bought at fair price or better.

That means I use a lot of watchlists and patiently wait to buy the right company at the right price. Well, the market correction, plus a disappointing drug trial result, mean that two of my favorite blue-chip drug makers, Johnson & Johnson (NYSE:JNJ) and AbbVie (NYSE:ABBV), have finally fallen to levels at which I can recommend them.

Let’s take a look at why these two industry leaders likely have what it takes to continue generating years, if not decades, of generous, safe, and steadily rising income. Traits that history indicates will lead to market-beating total returns, especially from their currently attractive valuations.

Johnson & Johnson: The Most Trusted Name In Pharma Continues Firing On All Cylinders

The pharmaceutical industry is both wide-moat and defensive (recession-resistant). That can make it a potentially attractive industry for low-risk income investors. And when it comes to big drug makers, none are lower-risk than Johnson & Johnson, which was founded in 1885 and is the world’s largest medical conglomerate. The company has over 250 subsidiaries operating in over 60 countries, making it the most diversified drug stock you can own.

(Source: JNJ Earnings Presentation)

All three of its business segments posted strong growth in 2017, resulting in company-wide operational revenue growth of 6.3%.

Metric

2017 Results

Revenue Growth

6.3%

Free Cash Flow Growth

14.4%

Shares Outstanding

-1.6%

Adjusted EPS Growth

8.5%

FCF/Share Growth

16.2%

Dividend Growth

5.4%

Dividend FCF Payout Ratio

51.3%

FCF Margin

23.3%

(Source: JNJ Earnings Release, Morningstar)

Excluding major acquisitions, such as the $4.3 billion purchase of Abbott Medical Optics and the $30 billion purchase of Actelion, operating revenue was up 2.4%. However, what ultimately matters to dividend growth investors is the company’s free cash flow, or FCF. That’s what’s left over after running the business and investing in future growth, and it grew by an impressive 16.2% last year. And despite the lower-margin medical products and consumer goods segment, JNJ still managed to convert 23.2% of its revenue into free cash flow in 2017.

FCF is what funds the dividend, and with an FCF payout ratio of 51.3% JNJ’s track record of 54 straight years of rising dividends is all but assured. In fact, the company will raise it again next quarter, with the analyst consensus being for about an 8% hike for 2018. That’s thanks to highly positive management guidance, including:

Metric

Mid-Range 2018 Growth

Operational sales

4%

Operational sales ex acquisition

3%

Total sales

6%

Operational EPS

8.20%

Adjusted EPS

11%

(Source: JNJ Earnings Presentation)

This is largely thanks to the strength of its pharmaceutical segment, particularly the oncology division, which saw worldwide sales growth of 25% and generated $7.3 billion in sales for the company. The strength of JNJ’s cancer drug business was largely fueled by such drugs as:

  • Darzalex (multiple myeloma): Worldwide sales up 117%
  • Imbruvica (lymphoma, Leukemia): Worldwide sales up 51%

These offset the small (9.3%) decline in global Remicade sales, which is the company’s blockbuster immunosuppressant that treats rheumatoid arthritis, psoriatic arthritis, ankylosing spondylitis, Crohn’s disease, plaque psoriasis, and ulcerative colitis. This decline was caused by the loss of patent exclusivity.

The good news is that while Remicade is in decline, other immunology drugs like Stelara (psoriasis and arthritis) are quickly stepping up to fill the gap. For example, in 2017, Stelara’s worldwide sales grew 24% to $4 billion, nearly matching Remicade’s $6.3 billion revenue.

In addition, JNJ is partnering with Theravance Biopharma (NASDAQ:TBPH) in a $100 million deal to develop its potentially far superior immunology drug to replace falling Remicade sales. That drug, TD-1473, is highly effective in very small doses. Early trials indicate it shows no significant broadscale immunosuppression, which has been the main side effect of all previous drugs in this category.

If future trials go well, then JNJ will likely pick up the tab for the drug’s registration costs, and its giant sales force will be responsible for marketing the drug. That’s in return for 2/3rd of US profits, as well as all global profits minus a double-digit royalty to Theravance.

This is great example of smart capital allocation, which reduces development risk immensely. JNJ has done this kind of co-development/co-marketing deal before. In 2011, it paid Pharmacyclics (now owned by AbbVie) $150 million to help it develop Imbruvica. Today, that cancer drug is one of Johnson & Johnson’s top sellers with nearly $2 billion in sales.

Pharmaceutical market analysis firm EvaluatePharma expects that figure to hit $7.5 billion by 2022, which is projected to make it the 4th-best selling cancer drug in the world. JNJ and AbbVie each have about 50% rights to Imbruvica, though AbbVie also enjoys royalty rights that it acquired when it bought Pharmacyclics.

Edurant, an HIV drug, also saw strong sales growth of 24.6%. This shows the major strength of JNJ. Which is that while most of its profits come from volatile, patented pharmaceuticals, it remains highly diversified, with even its largest medication representing only 8.2% of companywide revenue in 2017.

Best of all, JNJ’s drug development pipeline is deep, with 19 drugs in late-stage clinical trials for 85 indications in the US and the EU. And those are just late-stage phase three trials. In total, the company’s pipeline has 34 drugs, including 10 potential blockbusters that it expects to receive approval for by 2021. These are drugs the company thinks could generate over $1 billion in sales each.

This includes prostate cancer drug Erleada, which EvaluatePharma thinks could generate $1.6 billion in annual sales by 2022. Meanwhile, JNJ has Imbruvica in trials for seven more indications, four of which are expected to boost annual sales by at least $500 million each. All told, EvaluatePharma expects JNJ’s new drug/indication expansions over the next five years to drive $14.9 billion in additional sales, or nearly $3 billion per year.

And while it’s the least sexy part of the company, I like the consumer goods segment for its strong record of innovation.

(Source: JNJ Investor Presentation)

Consumer products has numerous highly trusted brands that have given the company a strong, non-patent reliant source of global revenue, including 55% from outside the US. In 2017, this segment’s sales grew 2.2%.

(Source: JNJ Investor Presentation)

In the last three years, JNJ has managed to use its enormous economies of scale to cut $1.7 billion in annual operating costs, resulting in operating margins rising by 4.5%. Going forward, the company expects to be able to achieve 1-2% above industry average growth, while achieving 20.3% operating margins.

Meanwhile, medical devices give the company much-needed diversification. It also provides a long growth runway given that in the future, global demand for surgical, orthopedic, cardiovascular, vascular, and vision devices is set to grow strongly.

Medical devices is a wide-moat industry, with JNJ controlling dominant positions in both orthopedics and endo-surgical devices (minimally invasive surgical tools). Surgeons are generally loath to switch suppliers, since they train and gain expertise using particular medical devices. This creates a stickier ecosystem and stronger pricing power.

The segment generated 5.9% growth in 2017. This was led by 46% growth in vision care (Abbott Medical Optics acquisition) and cardiovascular’s 13.4% growth in global sales.

The bottom line is that JNJ is a world-class drug maker, but also so much more. It has a strong track record of innovation and medical product invention in drugs, consumer products, and medical devices. Combined, these create a relatively steady river of free cash flow that has resulted in the industry’s best dividend growth track record – one that is likely to continue for many years and even decades to come.

AbbVie: Despite Recent Trial Failure, The Best Name In Biotech Still Has Plenty Of Growth In The Tank

Chart

ABBV Price data by YCharts

It’s been a rough few days for AbbVie, with shares plunging on news of disappointing phase two results for its Rova-T lung cancer therapy. Lung cancer, due to the large number of smokers in the world, is the most profitable sub-segment of the already very lucrative oncology market.

AbbVie paid $9.8 billion for Stemcentrx in 2016, including $5.8 billion up-front ($2 billion cash and $3 billion stock). The deal also included potentially $4 billion in cash earnout payments if the drugs developed from Rova-T hit certain milestones.

The reason that investors are reacting so negatively is that the results showed only 16% of cancer patients responded to the treatment, instead of the expected 40% response rate. So, AbbVie is abandoning plans to file for an early approval with the FDA.

This poor trial means higher risks of failure for the drug’s other trials, including much more important first- and second-line treatment indications. It also calls into question the Rova-T/Opdivo combination trial that AbbVie is partnering with Bristol-Myers Squibb (NYSE:BMY) on, and for which results should be in by 2019.

The biggest reason this freaked out investors so much is because AbbVie was spun off from Abbott Labs (NYSE:ABT) in 2013 with all of that company’s pharmaceutical assets. By far the most valuable has been the immunology drug Humira, which is used to treat arthritis, psoriasis, ankylosing spondylitis, Crohn’s disease, and ulcerative colitis. For several years now, Humira has been the best-selling drug in the world.

(Source: Statista)

This is why AbbVie has continued to put up incredible growth. In fact, in 2017, it had the best sales growth in the industry and came in number two in terms of adjusted EPS growth.

Metric

2017 Results

Revenue Growth

10.1%

Free Cash Flow Growth

43.7%

Shares Outstanding

-1.7%

Adjusted EPS Growth

16.2%

FCF/Share Growth

46.2%

Dividend Growth

5.4%

Dividend FCF Payout Ratio

44.1%

FCF Margin

33.4%

(Source: ABBV Earnings Release, Morningstar)

More importantly for income investors, AbbVie’s free cash flow exploded, thanks to the incredible margins it’s earning on its patented drugs.

Better yet? Thanks to tax reform, the company raised its 2018 Adjusted EPS guidance from about 17% to 32%, which is why management decided to hike the dividend for this year by 35%. However, the FCF payout ratio should still remain about 50%, due to the company’s strong growth in sales and free cash flow.

But if AbbVie is booming, then why is the market freaking out so much over Rova-T? Because AbbVie’s success with Humira is a double-edged sword. The drug was responsible for 65% of the company’s sales in 2017. This means that its prodigious profits and cash flow have a lot of concentration risk.

Investors are worried that AbbVie might end up going the way of Gilead Sciences (NASDAQ:GILD), where a single (in GILD’s case, two) blockbuster drug ends up seeing sharp sales declines that drag on earnings growth for years. That’s because in 2017, Humira lost EU patent protection. In addition, every major drug maker has a biosimilar rival in development.

The biggest risk was Amgen’s (NASDAQ:AMGN) Amjevita, which won approval in 2016. AbbVie has been battling in the courts to keep that rival off the market. In 2017, AbbVie and Amgen agreed that Amjevita would remain off the US market until 2023. That’s because while the FDA approved the rival drug, it didn’t take into account the 61 patents that AbbVie still has in effect.

Rather than proceed with a costly trial scheduled to begin in 2019, Amgen has backed down. This is why AbbVie CFO Bill Chase says that management has “come to the conclusion that this product [Humira] is durable.” And that investors are “not going to see anything catastrophic,” such as Humira sales falling off a cliff anytime soon.

In fact, AbbVie expects that with no biosimilar competition until 2023, it has a clear runway to keep steadily growing the drug’s sales.

(Source: AbbVie Investor Presentation)

But the point is that even if AbbVie’s rosy forecasts of Humira sales do come true, the company still needs to diversify if it’s going to avoid a major future decline in profits and cash flow.

After all, by 2023, the drug is going to face an onslaught of biosimilar rivals that will likely steal a lot of market share, or at the very least force AbbVie to reduce its prices significantly. In fact, by 2025, three years into competition with biosimilars, AbbVie expects Humira sales to fall to just $12 billion a year.

Which is why Rova-T was so important. Management believed that if approved for all indications, it could be a $5 billion blockbuster by 2025.

(Source: AbbVie Investor Presentation)

That was about 14% of the $35 billion in risk-adjusted (expected sales adjusted for probability of drug approval), non-Humira sales the company was forecasting for 2025.

In other words, Rova-T was such a big deal that the company spent a lot of money in order to try to reduce its Humira revenue concentration from 65% in 2017 to just 26% in 2025. However, the fact is that even if you assume a total failure on Rova-T, AbbVie’s sales should still come in at $42 billion by 2025, with Humira representing about 29% of revenue.

AbbVie: Lots Of Potential Growth Catalysts Ahead

Right now, AbbVie is all about Humira, the world’s most popular immunology drug and top-selling pharmaceutical period. But while immunology is indeed a booming industry, it’s far from the only growth avenue for this company.

(Source: AbbVie Investor Presentation)

In total, AbbVie thinks there is about a $200 billion market for the four key segments it’s targeting.

And the company has one of the deepest and most potentially profitable drug pipelines in the industry. In fact, in 2017, EvaluatePharma estimated that AbbVie’s new drugs in development could generate $20.4 billion between 2018 and 2022. That meant it had the third-strongest development pipeline in the world. Even if you assume a total failure of Rova-T, the new drug sales projection drops to $15.4 billion, which means that AbbVie’s pipeline drops to number four, just above Johnson & Johnson’s $14.9 billion. That’s because it still includes drugs like:

  • Risankizumab (psoriasis, ulcerative colitis, Crohn’s disease): $5 billion in projected 2025 sales off at least four indications
  • Upadacitinib (rheumatoid arthritis, dermatitis, Crohn’s disease): $6.5 billion in projected 2025 sales off at least six indications

And that’s just immunology. We can’t forget that oncology is going to become a major growth market in a fast-aging world where cancer becomes more common.

The leukemia drug Venclexta won approval in 2016, and is expected to generate peak sales of up to $2 billion. And of course, there’s Imbruvica, co-marketed with JNJ, which continues to put up massive growth as its number of approved indications increases. That drug’s peak $7.5 billion in annual sales potential would mean about $4 billion per year for AbbVie’s top line. Meanwhile, the drug maker has 23 drugs in development for solid tumors, with over 10 more expected to enter trials within a year.

Other opportunities to profit from demographics include Elagolix, an endometriosis drug. This is expected to generate up to $1.2 billion in annual sales by 2022.

And keep in mind that Rova-T’s results, while disappointing, were not necessarily a disaster. That’s because the results showed that Rova-T increased one-year survival probability from 12% with current treatments to 17.5%. That is why Morningstar’s pharmaceutical analyst Damien Conover thinks it might still obtain approval for most of its first and second line indications. That could mean total peak sales come in at $1 billion, down from Morningstar’s $3 billion projection before the trial results came in.

The point is that even if you assume the worst-case scenario – i.e., zero revenue from Rova-T – AbbVie is still looking at potential sales growth of 5.2% CAGR through 2025. And if Rova-T manages to get approved, then that figure could rise to 5.3%. And with strong operating leverage from economies of scale (cost savings driving EPS growth faster than revenue growth), that means that AbbVie’s long-term EPS and FCF/share should still come in between 10% and 15%.

Which, in turn, means that AbbVie investors can likely expect some of the best dividend growth from any drug maker in the coming years. Combined with its mouthwatering yield, that makes it a very attractive income investment right now.

Dividend Profiles: Safe And Growing Dividends Likely To Result In Market-Beating Total Returns

Stock

Yield

2017 FCF Payout Ratio

Projected 10-Year Dividend Growth

Potential 10-Year Annual Total Return

Johnson & Johnson

2.60%

51.30%

7% to 8%

9.6% to 10.6%

AbbVie

4.00%

44.10%

10% to 14.2%

14% to 18.2%

S&P 500

1.80%

32%

6.20%

8.00%

(Sources: Company Earnings Releases, Morningstar, F.A.S.T. Graphs, Multpl.com, CSImarketing)

The most important part of any dividend investment is the payout profile, which consists of three parts: yield, dividend safety, and long-term growth potential. This determines how likely it is to generate strong total returns and whether or not I can recommend it or buy it for my own portfolio.

Both Johnson & Johnson and AbbVie offer far superior yields to the market’s paltry payout. More importantly, both dividends are very well-covered by free cash flow.

However, dividend safety isn’t just about a reasonable payout ratio. It also means checking to see whether a company’s balance sheet is strong enough to support continued investment in future growth as well as a rising dividend.

Company

Debt/EBITDA

Interest Coverage

Debt/Capital

S&P Credit Rating

Average Interest Cost

Johnson & Johnson

1.4

26.0

32%

AAA

2.7%

AbbVie

3.6

9.0

72%

A-

3.1%

Industry Average

1.8

12.5

41%

NA

NA

(Sources: Morningstar, GuruFocus, F.A.S.T. Graphs, CSImarketing)

Here is where JNJ takes a clear lead over AbbVie. Johnson & Johnson’s leverage ratio is below the industry average, and its sky-high interest coverage ratio indicates that the company has no trouble servicing its super cheap debt.

In fact, JNJ is just one of two companies (the other being Microsoft (NASDAQ:MSFT)) with a AAA credit rating, which is one notch higher than the US Treasury’s. That’s why it is able to borrow at such attractive rates.

AbbVie, thanks to a slew of acquisitions in recent years, has a much-higher-than-average leverage ratio. In addition, its interest coverage is below that of most of its peers. However, while this high debt load is something I plan to watch carefully going forward, it isn’t yet a danger to the dividend. After all, AbbVie still has an A- credit rating and is able to borrow at very cheap rates as well. But in a rising interest rate environment, that might change. So it’s good that management plans to hold off on more acquisitions for now, while it uses the company’s enormous and fast-growing river of FCF to pay down debt.

As for dividend growth potential, this is of key importance, because studies indicate that a good rule of thumb for future total returns is yield + dividend growth. This is because, assuming a stable payout ratio, the dividend growth rate must track earnings and cash flow growth. And since yields tend to be mean-reverting over time, this combines both income and capital gains into one formula.

JNJ’s dividend growth rate potential is smaller than AbbVie’s, due mainly to its larger size. This makes it harder to grow quickly. However, analysts still expect about 7-8% earnings growth from this Dividend King. That should allow for similar payout growth and result in market-beating total returns.

AbbVie’s dividend growth outlook is more uncertain, though larger, thanks to its strong development pipeline. Unlike JNJ, AbbVie has no diversification into non-drug businesses, and so, its growth is more unpredictable and volatile.

However, I conservatively estimate that AbbVie should be able to achieve 10% dividend growth, while analysts expect about 14%. When combined with today’s attractive yield, that should be good for about 14% total returns. That’s far above what the S&P 500 is likely to provide off its historically overvalued levels.

Valuation: JNJ Is Finally Fair Value, While AbbVie Is On Sale

Chart

JNJ Total Return Price data by YCharts

Up until a few months ago, both JNJ and AbbVie investors were enjoying a very solid year. JNJ was tracking the market during a freakishly low-volatility 20% run in 2017. AbbVie was booming thanks to strong growth in Humira and the news that its cash cow wouldn’t get any competition until 2023. However, in recent weeks, JNJ and ABBV have suffered major losses that make them both potentially attractive investments.

Company

Forward P/E

Historical P/E

Yield

Historical Yield

Percentage Of Time Yield Has Been Higher

Johnson & Johnson

15.5

22.4

2.60%

2.90%

40%/30%

AbbVie

13.0

21.5

4.00%

3.00%

11%

(Sources: GuruFocus, F.A.S.T. Graphs, YieldChart)

JNJ and AbbVie are now trading at lower forward P/E ratios than their historical norms. More importantly, AbbVie’s yield is much higher than it’s been since the company’s 2013 spin-off. JNJ’s yield is not, but keep in mind that the company’s about to announce its 55th straight annual dividend bump. This should raise the forward yield to about 2.8%.

And even at a 2.6% dividend yield, JNJ’s payout has only been higher 40% of the time. And going off the likely 2.8% forward yield in a few months, 30%. Meanwhile, AbbVie’s yield has only been higher 11% of the time, indicating that it’s likely highly undervalued.

(Source: Simply Safe Dividends)

A rule of thumb I like to use for determining fair value is that I want to buy a stock when the yield is at least at the 5-year average. Taking into account the upcoming JNJ dividend hike, I now estimate that it is fairly valued. And under the Buffett principle that “It’s better to buy a wonderful company at a fair price than a fair company at a wonderful price”, I have no issue recommending JNJ today. After all, it’s the ultimate pharma blue chip, with the best dividend growth record in the industry.

Meanwhile, AbbVie is about 17% undervalued, which is why I consider it a more attractive investment today. That’s why I added it to my own portfolio during the recent correction and during the Rova-T freakout.

Note that if I had the cash, I’d have bought JNJ as well, and I highly recommend owning both blue chips in your diversified income portfolio. That’s assuming, of course, that you are comfortable with the complex risk profile of any pharma/biotech company.

Risks To Consider

When it comes to complexity and uncertainty, few industries are as challenging as pharma/biotech. That’s because of numerous risk factors that make it very challenging for companies to consistently grow safe dividends.

For one thing, the same regulatory hurdles that provide a wide moat and windfall profits for a time also make new drug development incredibly tricky and time-consuming.

(Source: Douglas Goodman)

For example, fat profit margins are created by patent protection, which usually lasts for 20 years. However, drug makers need to file for a patent at the start of the development process, which usually takes 10-15 years to complete. That means drug companies only enjoy patent-protected margins for a relatively short time before patent cliffs kick in and generic competition can steal market share.

And we can’t forget that the process itself is highly unpredictable, monstrously expensive, and only getting more so over time.

(Source: Tufts Center For The Study Of Drug Development, Scientific American)

When factoring in all the preclinical, clinical, and follow-up studies, it can cost as much as $2.6 billion to develop a new drug. And as we just saw with Rova-T, a promising drug can fail at any time. That can potentially result in a total write-off and gut-wrenching short-term price volatility.

Worse yet, because only about 1 in 10,000 compounds/treatments ends up making it through the FDA regulatory gauntlet, drug makers often have to acquire rivals to obtain promising pipeline candidates in late-stage development. All major M&A activity is inherently packed with risk.

For example, if a company overpays, then even a successful blockbuster drug can end up not contributing much to EPS or FCF growth. Meanwhile, synergistic cost savings, which are often counted on to make deals profitable, might not be fully realized. And what if a key drug that was a major reason for a large acquisition fails in trials? Then large write-offs can result, as may happen with Stemcentrx and Rova-T. And don’t forget that a failed acquisition can lead to a costly break-up fee. For example, in 2014, AbbVie abandoned the $55 billion attempt to buy Shire (NASDAQ:SHPG), resulting in a $1.6 billion break-up cost to shareholders.

The good news is that according to AbbVie’s CFO, when it comes to additional short-term acquisitions, investors shouldn’t “expect anything major.” That’s because, he said, “Running out and buying something of size doesn’t make sense.” Holding off on more acquisitions for a few years means that the company will have time to deleverage its balance sheet while it brings its strong development pipeline to market.

In addition, AbbVie does have a pretty good track record on acquisitions, since the $21 billion purchase of Pharmacyclics in 2015 was reasonably priced. It gave the company the blockbuster Imbruvica, which is its second-largest but fastest-growing seller.

But even if everything goes right, a company makes a smart acquisition at the right price, and the potential blockbusters in the pipeline are approved, there’s the issue of massive competition to contend with. For instance, patents on drugs are highly specific. Competitors are free to create alternate versions, including of highly profitable biological drugs. That’s why every pharma/biotech and their mother is constantly racing to develop biosimilars to the hottest blockbusters on the market.

In this case, Remicade faces competition from over 20 potential rivals, including Pfizer’s (NYSE:PFE) Inflectra, which is selling at a 10% discount to Remicade. And without patent protection, analysts expect Remicade sales to continue to deteriorate at an accelerating pace. Meanwhile, JNJ prostate drug Zytiga is also expected to see generic competition this year, due to patent expirations.

In order to keep their pricing power, pharma companies are also fighting constant legal battles. That’s to protect patents and also to try to block generic and biosimilar competition for as long as possible. All legal challenges are themselves highly uncertain, and a negative outcome can have a large impact on both the share price and future cash flow growth.

And we can’t forget about the other kind of legal uncertainty: class action lawsuits in case an approved drug ends up being harmful to consumers. For example, Merck (NYSE:MRK) had to pull popular pain drug Vioxx from the market in 2004 when post-clinical studies showed it significantly increased the risk of heart attack and stroke. The company has spent over 12 years in and out of courts, as a plethora of class action suits have continually pushed up the final settlement costs. In 2007, Merck settled most of the cases for $4.9 billion. But individual holdouts have continued suing the company, and the total cost is now at $6 billion, with several cases left to be settled.

And that is just one extreme case of what can go wrong. Often, legal liability is a death from a thousand cuts. For example, AbbVie recently lost a case in Chicago where a man successfully sued over AndroGel, a testosterone replacement cream. The plaintiff claims that AbbVie’s cream caused him to have a heart attack. While the jury did not find the company strictly liable, it still awarded him $3 million. The company faces about 4,000 more such cases over AndroGel. Each case is likely to have a different outcome, and some of them might be thrown out or be reduced on appeal. But the point is that even non-blockbuster products can end up as a major financial liability.

Meanwhile, in the past, JNJ has faced its own legal hassles, including numerous consumer product recalls, defective knee, hip implants, surgical mess, and a $2.2 billion settlement over antipsychotic drug Risperdal.

Finally, we can’t forget the other major legal risk: government regulations and healthcare policy, both in the US and abroad.

(Source: HCP)

In the US alone, the rapidly aging population means that healthcare spending is expected to increase by about $2 trillion per year by 2025 and consume 20% of GDP. This means that the US government as well as private payers will be desperate to bend the cost curve lower. Blockbuster drugs and their high profit margins are an easy target for populist politicians to go after in this country and around the world.

For example, President Trump announced that:

“One of my greatest priorities is to reduce the price of prescription drugs. In many other countries, these drugs cost far less than what we pay in the United States. That is why I have directed my Administration to make fixing the injustice of high drug prices one of our top priorities. Prices will come down.”

The president has also said in the past that drug makers were “getting away with murder”, a sentiment many Americans share. And it is true that foreign countries do enjoy lower drug prices, largely because government involvement in healthcare is far more common. Of course, that is why most R&D recoupment is generated in the US.

But that’s not guaranteed to continue. Because even if Congress doesn’t enact outright price controls on drugs, it can easily lift the current ban on Medicare/Medicaid negotiating bulk drug purchases at a discount. That’s a far less controversial proposal that represents low-hanging, cost-saving fruit – one that could potentially hit margins across the entire industry.

In the meantime, Joaquin Duato, JNJ’s executive vice president and worldwide chairman of its pharmaceuticals segment, has said that insurers and pharmacy benefit managers are putting on extra pressure to lower drug prices. This is why the company’s pharma growth plans are focused on volume and not price. It wants to grow profits by expanding indications and launch new medications to treat more conditions, specifically in immunology and oncology.

The bottom line is that pharma is a wide-moat industry with huge potential for future growth. However, it’s also fraught with peril and risk. Drug makers face a never-ending hamster wheel of uncertain, time-consuming, and costly drug development. This means steady growth in sales, earnings, and cash flow is very challenging.

Only enormous economies of scale, highly skilled capital allocation by management, and safe and growing dividends make it worth considering the industry at all. Which is why I avoid all but the most proven blue chips in the industry, and recommend most investors do the same.

Bottom Line: These 2 Industry-Leading Blue Chips Are Likely To Make For Strong Long-Term Income Investments At Current Prices

The drug industry has a lot of favorable characteristics. It’s recession-resistant, wide-moat, and is potentially poised to enjoy a major secular global demographic growth catalyst in the coming years and decades.

That being said, it’s also one of the most complex, cyclical, and competitive industries in which you can participate. That means the best course of action for most investors is to stick with industry-leading, blue-chip dividend stocks – those with shareholder-friendly corporate cultures and proven management teams.

Johnson & Johnson and AbbVie represent the top names in pharma and biotech, respectively. And at current valuations, I am able to recommend both for anyone looking for low-risk exposure to this defensive industry. That being said, AbbVie has better total return potential, and its recent disappointing drug trial results mean that the company is far more undervalued. That’s why I bought it over JNJ for my own portfolio during the correction.

Disclosure: I am/we are long ABBV.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

General Electric Capitulates Offering Interim Buying Opportunity

It has been one hell of a year for General Electric (GE) and its beleaguered shareholders. Bullish investors have suffered mightily watching their funds evaporate as the stock fell 65%, punishing anyone in the name.

Yesterday, the Wall Street Journal published a relatively bearish article that allowed traders to pile on to the downside with the stock breaking the $13 level and trading down to $12.70. That matched a low not seen since the heart of the financial crisis.

I read the article but did not see a real reason to spin it as a sell sign. There was no new news there. In my view, this is the type of situation that happens when a stock is capitulating and media outlets pile on, kicking a company when it is down.

As I watched GE hit $12.70, I thought to myself, is this company needing a loan from Warren Buffett? No.

Are we in a financial crisis with a contracting economy? NO.

Is sentiment as bad as I have ever witnessed in GE? YES. I then pushed the buy button and added to an upside down position with reservations.

Here are few questions for the average investor to keep it simple.

  • Are conditions better for GE now than they were in 2009? I think the answer is yes.
  • Does GE have more or less shares outstanding than 2009? It has less shares outstanding.

Here is a chart showing the share count for interested investors.

Source: GE macrotrends

As you can see, the share count was over 10B in 2009, it is now around 8.6B shares.

  • Is the global market in which GE operates in recession? No, as a matter of fact, the world economy is growing in sync for the first time in over a decade.
  • Is the negative news overdone? Are we dealing in reality or is the market trading on fear?
  • Is there a positive catalyst that can take the stock higher? That is a little more difficult question to answer. For me, the answer is maybe.

GE has been a huge disappointment for many years. There have been hundreds of articles over the last few months about GE and all of its problems.

I would like to take a moment to focus on Price and entry points.

What is GE worth?

Today, the stock is worth $13.32 a share as I write this article. Yesterday, it was worth $13.23 to $12.70. I think the sell-off is way overdone, but the fear factor is real, and the margin calls are real.

My downside price target of $12.80 was hit yesterday. To me, it is worth $12.70. I bought it yesterday from $12.71 to $12.92. I may sell the rally, trading around my position and trying to get out with my scalp. I think the stock is worth around $15 to $18 a share by June 2019.

Bottom line is this: GE is a global digital business. The stock price will vary from day to day. Sometimes, it will trade at a significant discount to the business and its underlying fundamentals.

In my view, $12.70 represents a value that will cause the bulls to step in and stage a rally that could last into earnings.

Here is a look at a 10-year monthly chart.

In looking at the monthly chart above, one can see the sell-off in 2008 and 2009 and the 10 years that follow. Very few traders in the markets thought the stock could go down and break $13, but I did.

I wrote an article back in January stating more capitulation to come. In that piece, I wrote that GE could break $13 after hearing about the $22B GE Capital bombshell. I set a buy target of $12.80 back then and decided to stick with my unemotional thesis based on behavioral finance.

Important Note: GE only traded under $13 for a few short months in 2009 when the financial world was burning down and fear was everywhere. It is a very different world now, and in my view, GE is going to be fine.

Is GE a buy three months later at $13?

Maybe, if there is evidence of a solid sustainable turnaround and the clouds of uncertainty are raised. Right now, uncertainty is everywhere. There are far better stocks to buy that are going up, stocks with great earnings growth.

Mario Gabelli was buying GE in January at $16.

Two months ago, Kevin O’Leary said he would buy it at $13.

Now, Mr. wonderful just said on CNBC that he wants to buy the stock at $7 to $8. I get it. I have done the same thing many times. However, the market makes all of us look a little silly at times, and while GE may hit $8 a share, in my view, it is highly unlikely.

It is normal behavior to watch a stock get way oversold on highly negative sentiment and not be able to pull the trigger; only to watch it go on a quick 15% to 20% sharp rally with you on the sidelines.

This type of arrogant attitude is bullish to me as it may embolden shorts which could help the stock rally near term. He says “it can go to $8 easily.” I disagree. That was the height of hysteria, and the reason it went to $5.65 was a fake news story about BK, which was false. I bought it that day and owned it on March 9th when the market bottomed with a cost basis of $8.28.

It might be better to put your money into financials like Bank of America (BAC) under $28 or Citigroup (NYSE:C) on weakness. They are both growing earnings and raising dividends. Rising interest rates will do wonders for their bottom lines. Apple (AAPL) is a cash-generating monster with a continuing revenue stream and great margins.

The market is ignoring any positive news coming from GE at the moment

The new $1.3T government spending bill will likely be a huge positive for GE going forward. It stands to make some great profits on all different types of defense spending, which is totaling $700B. That is extremely bullish for GE and its future, but when a stock is in capitulation, many investors cannot ignore the noise.

Look at this slide from a JPM presentation showing what it makes for defense spending. The market is missing the boat with GE and its prospects for the future, in my opinion.

Bear case

GE Capital is going to be a drag on earnings for years to come. The $22B hit that the company took on the last conference call scared the hell out of most investors, including me.

Margins are getting squeezed with profits down 88% in the power division.

GE pension problems are out of control. (I disagree).

The Alstom acquisition is a disaster, and it will never be able to make the business model work.

SEC headlines in regard to GE Capital will remain a risk to the stock.

Bull case

Extreme pessimism around the stock is a contrarian play. GE has intrinsic value, but the market is not giving any value to GE as a company. Enterprise value is how much? Zero? I am not an expert, but as a long-term trader, I would give the company a minimum value of $5 for enterprise value, and in my view, that is conservative.

Aviation earnings should do great as worldwide jet engine growth spending ramps up over time.

Earnings report on April 20th should be terrible

I am expecting an earnings miss and more write-downs on the next call. I expect nothing good to come out of energy this fiscal year. This may be the worst quarter of the year for GE. Any positive news and clarity around GE Capital could pop the stock 10% overnight. A major earnings miss and investors could see a sell-off that takes the stock to new lows.

Conclusion

GE is in the dog house, although today is the biggest rally day in many years. The stock has hit a capitulation level that I believe could launch an interim rally as bulls force short covering going into earnings.

The company’s share count is over 2 Billion shares lower than 2009. The global economy is buzzing along with synchronized growth. While GE has problems, the company is slowly working through its issues.

I am not bullish on the name but believe that an interim rally point may have been reached at the $12.70 level. Today’s trading activity is a good sign for beaten-down shareholders suffering under years of bad management.

April 20th is the next report card for GE. Investors will be looking for clarity on GE Cap. and free cash flow growth. I see GE going nowhere fast as this year will be a reset. While I am long the stock, I will be looking to exit and hedge on rallies.

An announcement of a big-time investor like Warren Buffett could pop the stock 5% to 10% in a heartbeat. Investors will be watching closely to see who the new whale is jumping into GE.

Short squeezes are the start of many individual stock rallies, and they can happen very quickly and keep going, wringing out shorts. From there, improving fundamentals can take a stock higher.

As always, I encourage investors to do their own due diligence and make their own decisions and always have an exit strategy in place before making any trades.

Disclosure: I am/we are long GE.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.