(Reuters) – After lagging a 6-year healthcare sector run fueled by fast-growing biotech companies, Johnson & Johnson (NYSE:JNJ) shares have beaten the group in 2016 as investors turn to safety in rocky equity markets.
But with the stock price now hovering near its $110.35 record high, that strategy may be in doubt. J&J shares already have risen to the level that the average analyst has targeted for them, and sell at a healthy premium to large pharmaceutical companies such as Pfizer (NYSE:PFE) and Merck (NYSE:MRK). Relative to their own future earnings, the shares are more expensive than they have been in more than a year.
“What I am more concerned at this juncture is, do we see more follow-through or do we see profit taking?” said Arthur Henderson, portfolio manager of the global healthcare equity fund at the Tennessee Consolidated Retirement System, where he has recently sold some J&J shares so they account for a smaller part of the fund’s holdings.
J&J shares could build on their gains if investors rekindle worries about the broader economy or continue to hide from concerns facing the pharmaceutical and biotech industries, and some analysts are optimistic about the company’s pipeline of experimental medicines. But, ultimately, the company will have to produce enough earnings growth to justify the higher prices.
On that front, the company faces a fresh competitive threat to its biggest drug franchise. U.S. regulators earlier this month approved a rival version of the company’s Remicade treatment for conditions such as rheumatoid arthritis.
J&J’s 1st-quarter report, due on April 19, is expected to show earnings up 6% over the same quarter a year ago, on a 0.6% increase in sales, according to Thomson Reuters data. Wall Street analysts are predicting fairly consistent annual earnings growth between 5% to 6% over the next few years.
In January, the company projected that its calendar year 2016 profits would ultimately be up 5% to 8% over 2015 and it would aim to significantly increase its operating margins.
“Most pharmaceutical companies have cut fat over the past years and my sense is what it implies is they can cut some extra fat,” said Tony Butler, analyst at Guggenheim Securities.
J&J’s product diversity makes it more immune than other drug stocks to political pressures on the cost of medicines.
The company’s pharmaceutical unit accounted for 45% of its $70 billion in sales last year, with medical devices totaling more than a third and over-the-counter medicines and other consumer products making up the rest.
The shares are up 7% in 2016 against a 3% decline for the S&P healthcare sector. The company’s shares had underperformed the sector every year dating back to 2009 as J&J also grappled with a slew of product recalls and manufacturing setbacks for its consumer division.
At 16.6 times estimated earnings over the next 12 months, the stock is still slightly cheaper than the valuation for the overall S&P 500.
Investors also are drawn to J&J’s 2.7% dividend yield, which nonetheless lags Merck and Pfizer, which both yield more than 3%.
“People right now are paying up quite a bit for that safety piece of it,” said Morningstar analyst Damien Conover, who puts fair value for the shares at $102. “I think it’s overvalued, but I do think there are characteristics in the economy and political landscape that bode well for J&J.”