Johnson & Johnson (JNJ)

Some companies possess superior business characteristics and JNJ is one of them. In reviewing JNJ's annual reports since 2000, I discovered that the cash position has moved from roughly $4 billion to roughly$16 billion. This fantastic growth in cash is even more stunning because it has been accompanied by a strong dividend payout and a reasonable share buyback. Look at the numbers since 2000.

JNJ has doubled in sales and earnings and earned roughly $40 billion for the period. JNJ has grown cash by $12 billion. JNJ has repurchased $6 billion of stock. JNJ has paid $15 billion in dividends. The remaining $7 billion or less than 20% of earnings is all that has been needed for a growth rate greater than 10% per year. That's amazing.

Is it all good news? No, it rarely is. Strong results often create excess confidence. JNJ overbid for Guidant. Fortunately, Boston Scientific got frenzied in the bidding and "succeeded" in the purchase of Guidant. Not happy with the "missed opportunity," JNJ has now paid a very high price for the consumer products line of Pfizer.

The other looming problem is JNJ's pension plan. Not only is it underfunded, the plan assumptions also appear aggressive, meaning the plan is even more significantly underfunded. JNJ's management does not appear to have taken steps (such as IBM's freezing of their plans) to address these issues.

International Corporate Tax Rates

In a recent annual report, Warren Buffett complained about the disproportionately high share of corporate income taxes that Berkshire Hathaway (BRK) was paying. And paying close attention to what he says, I spent some time looking at the issues involved.

I found that most companies of BRK's size are more internationally diversified. As a result, a wide range of tax planning (or manipulating) is legitimately available. Countries are competing for high quality jobs to be put into their jurisdictions. As a result, the U.S. is now in a group with the highest statutory tax rate at 35%. The others are India, Malta and Spain. The lowest tax rate country is Ireland at 12.5%.

Looking at the likelihood of tax structures is important. A recent study demonstrated that "the effect of a single percentage point reduction in tax rate was the equivalent of the company generating a 15% increase in its sales over a 10 year period." With sales growth generally slow, this shows tax planning has a huge impact. Is there downside to this?

Of course. But after looking around Europe and "the world is flat" thesis, I really think most countries are going to competitively lower corporate tax rates to attract the best working populations and employment opportunities. Technology and pharmaceutical companies should continue to benefit as research employees probably represent highly desirable citizens (high incomes and education levels).

The Foreigness of the Japanese

Recently my family and I were travelling in Europe. While there, it was difficult to ignore the prevalence of natural body odors. Getting back home to reseach, I focused on the geographic differences in the personal care area. But despite the notable difference in smells, the financial differences between the U.S. and Europe personal care segments were only slightly different. The real difference is between Japan and everyone else.

Estee Lauder presented a study comparing the sales of prestige cosmetics to females 15 and older in various markets. It was no surprise that the low end of the scale was held by India with $0.43 per female, next by China at $1.19 per female and up to Russia with $9.03 per female in the developing world. In the developed world, the U.S. and the U.K. were close with $113.22 and $116.96, respectively. The shock was Japan at a whopping $236.82 per female.

Sensing an investable idea, I invested more time in the Japanese cosmetic area and found other facts about the Japanese. 85% of Japanese women between 18 and 65 dye their hair. Only 2.3% of Japanese women between 16 and 64 feel good about their skin. And Japanese women use 50-100% more cosmetic products than other women in the world.

Interestingly, the high expenditures per female seems to have not increased their sense of self worth. Nor have these expenses increased the birth rate or the rate of sexual activity. In a recent survey, the Japanese had, by a huge margin, the lowest rate of sexual activity in the world at 45 times per year against a world average of 103 and a U.S. average of 113.

After this research, I began to sympathize with the management of Colgate-Palmolive (CL). CL views Japan's markets as so foreign that this personal care powerhouse sells only one product in Japan: Hill's pet food.

Will "Alternative" Foods Go Mainstream?

Since Whole Foods built a new store in Highland Park in 2001, I have been a regular at the store. Despite higher prices, I was attracted to a much higher level of cleanliness, a thorough description of food content and the option of no and low fat foods. In the meantime, I watched Tom Thumb close down a recently remodeled store and asked myself, "why don't they sell some of those Whole Food products?"

The recent purchase of 84% of Tom's of Maine by Colgate-Palmolive (stock symbol:CL and founded in 1806) for $100 million points to movement in that direction. Tom's of Maine was started in 1970 by Tom Chappell as a "natural" product category company with deodorants and toothpastes. Last year sales were about $50 million. In light of Tom's high profit margins, it doesn't appear that CL overpaid. Rather, Tom's will get heavyweight distribution and CL will begin to get that product line that Tom Thumb lacked. Winners all around?

Not likely. It looks like Whole Foods may be the ultimate loser through franchise erosion. As production and distribution gets more efficient for Tom's through CL's efforts, other food chains will have the ability to carry such products. While Whole Foods may argue that Tom's should not diminish its brand by selling through inorganic, animal-haters, CL will logically argue that if Tom's is good for the world, why limit its distribution?

Media Patterns

This graph was supplied by Advo in their 2005 Annual Report to describe patterns in advertising. The three categories of high increases are direct mail, cable TV and internet, causing direct mail to surpass newspapers and cable TV to surpass radio. In an age of increasing complexity, the simple act of stuffing our mailboxes continues to grow in value.

Auto Insurance Cycles

The 2005 annual report of Progressive presents an impressive graph. It depicts the rarity of the recent trend of profitable underwriting. The profits of the last three years have been unmatched since the late seventies. Inquiring minds will want to know: what's the similarity? For my part, I believe that investment returns had been miserable then, as they have been recently. When profitable investments justify underwriting insurance at a loss (as was the case in the eighties and nineties), then companies compete to irrational pricing levels. If this reasoning is correct, there is no reason to expect that the cycle will change dramatically, as investment profits are still uncertain.

(By the way, thank my daughter Tessa for this first blog image. Without her help, I could not have gotten it done.)

The World of Risk according to MBIA

MBIA is the world's leading firm in credit enhancement - similar to the dangerous business of "co-signing" a loan - but getting paid for it. MBIA has insured $2 trillion of debt with a loss rate of only .04% or 4 basis points. That's alot better than the record of most "co-signers." As a recent test of this "no-loss" approach, MBIA's $33 billion balance sheet only had to pay out $2 million for the hurricane damages last year, and has already been fully reimbursed. Risk is MBIA's specialty.

MBIA's comments in the 2005 annual report confirm some of my observations on risk: "We believe the perception of risk is very much understated relative to the level of real risk in today's market." CEO Gary Dunton does not explain what he views as the cause of such a change, only stating, "we do not believe that the characteristics of today's market reflect a new and permanent economic paradigm."

The annual report does not state how extreme today's case is. A normal spread between a "credit enhanced" AAA and a AA 10-year municipal bond is 25 basis points. So, on $10 million, the "credit enhanced" AAA issuer gets to pay $25,000 less in interest for the higher rating. What is the spread in today's ebulliant period? Zero.

MBIA went through a similar situation in 1999, when a powerful economy and excitement over technology stocks combined to remove any sense of risk. Then and now, MBIA'a underwriting revenues dropped significantly. The business cycle may have been tempered, but the risk cycle is alive and well.