Sell Alert: Johnson & Johnson (JNJ)

We added global health care conglomerate Johnson & Johnson (NYSE: JNJ) to our Growth Portfolio eight years ago. Since then, it has returned more than 160% in dividends and share price appreciation.

However, JNJ has been stagnant for the past eighteen months, slightly worse than the overall stock market. Weighing on the stock are two concerns that we feel are likely to drive it lower over the next 6 – 18 months, so we are removing it from our portfolio.

Opioids and Baby Powder

There are two major threats to JNJ that are coming to a head simultaneously. The first threat is legal in nature involving class action lawsuits that have a decent chance of prevailing against the company.

As we discussed at the start of this year (“JNJ: On the Same Road as Volkswagen?”), JNJ is becoming increasingly mired in lawsuits involving the alleged use of asbestos in its baby powder products many years ago.

At that time, we moved JNJ to a ‘hold’ and said that “if it turns out Johnson & Johnson’s management team actively engaged in hiding information from government regulators that it knew to be in violation of the law, there may be a lot more pain in store for JNJ shareholders.”

Since then, an Oakland, California jury awarded $29 million to a woman with mesothelioma that she alleged was the result of using JNJ’s baby powder. That’s chump change compared to the $4.7 billion verdict against JNJ last year, but underscores the fact that the company is vulnerable to more negative outcomes in the estimated 12,000 unsettled lawsuits still outstanding.

In addition, JNJ is now at the center of a lawsuit brought by the state of Oklahoma over opioid use. Although the potential monetary award if JNJ loses is not enormous, it could set a dangerous precedent for a much larger multidistrict lawsuit making the same allegations in Ohio.

Medicare for All

The second threat is political, with upcoming democratic presidential debates most likely featuring some form of “Medicare for All” as a central topic. Depending on the status of the class action lawsuits at the time the debates are held, it is possible that JNJ may be vilified by the debate participants as an example of how big pharma has abused the public trust similar to how Wells Fargo has become the poster child for misdeeds by big banks.

As we stated back in April (“Murky Future for Drug Stocks”), we don’t believe Bernie Sanders version of Medicare for All has much chance for passage since its cost would be extraordinarily high. However, the topic will get considerable media attention over the course of the democratic debates, which may be enough to scare investors out of health care stocks.

The specific risk to JNJ is that it could be attempting to settle two very public class-action lawsuits at the same time it is being singled out as an example of why the federal government needs to be more involved in the management of the health care delivery system. That type of unwanted attention could sway public opinion enough to result in a large financial award against JNJ.

Two Strategies for Holding Out

The timing of these two events creates a quandary for long term shareholders of JNJ. If you have a large embedded capital gain and do not wish to realize it this year for tax purposes, then you may prefer to continue to hold JNJ into next year. But since the upcoming presidential debates and the outcome of the class action lawsuits will both occur before the end of this year, it is possible that an unfavorable outcome could result in a bigger loss than the size of the tax liability avoided.

For that reason, if you decide to hang on to your shares of JNJ then we suggest you consider guarding against the possibility of a big drop in JNJ’s share price by either putting a firm stop order beneath it or buying an out-of-the-money put option. Either way, you can specify exactly how much downside risk you are willing to accept in exchange for holding on to the stock.

Of course, it’s also possible that JNJ may make it through the end of this year without any further damage. For that matter, favorable outcomes in Oklahoma and Ohio could push its share price higher. But considering JNJ is trading less than 10% below its all-time high, we feel the downside risk is considerably greater than its upside potential. Sell Johnson & Johnson.

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