Was The Recent Price Correction In Johnson & Johnson Stock Justified?

Johnson & Johnson (NYSE:JNJ) has been facing thousands of lawsuits against its talc products. The stock price recently dropped over 10% following the article stating that the company was aware of its baby powder products being tainted by asbestos. However, it appears that the market overreacted, which likely prompted J&J to announce a $5 billion share buyback program. For an argument, to look at a worst case scenario, we have created an interactive dashboard ~ Did The Market Overreact Following Reports That J&J Knew Its Baby Powder Was Tainted By Asbestos ~ that shows our analysis on litigation expenses, if the company were to settle all talc related cases in 2019, and its impact on the company’s forward earnings and share price estimate.

There are roughly 11,700 talc related cases against J&J, and if all of them were to be settled next year at an average cost of $280,000 per case, it will translate into $3.3 billion incremental litigation expenses for the company. We add that to estimated expenses for J&J, and arrive at earnings of $7.17 per share, which is roughly 15% below our estimated $8.40 EPS for J&J in 2019. Using the price to earnings multiple of 18x, we arrive at a share price estimate of $131. In this scenario, the price correction is justified. However, it is a very unlikely event that the company will end up paying such an amount next year. The company would likely appeal if there were any such judgement, as has been the case historically, and many of lower court verdicts against J&J have been reversed later. As such, the fall in the stock price to these levels appears to be a stretch, in our view.

J&J’s litigation expenses have been fairly high over the past few years. The company spent $2.5 billion in 2017, $806 million in 2016, and $141 million in 2015 (which includes gains from the litigation settlement agreement with Guidant for $600 million). While some of these expenses were related to the medical devices segment, it will be interesting to see how this figure trends in the coming years, given the number of lawsuits the company is facing.

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