For investors around the world, this past Tuesday was a dramatic demonstration how the realization of risk can adversely impact markets and individual portfolios.



The Panic started in China, then worked its way through Europe and then to the U.S. markets.

The sell-off snowballed and led to a full blown meltdown by early afternoon and there was not really any place to hide.

But as a long-term investor, one needs to consider what actually changed from Monday's close.

Other than the calendar, virtually nothing was significantly different.

The economy, although being revised down, remains solid. Corporate earnings, although not growing at robust double-digit rates, are still growing a respectable 7-9%.

However, anyone who sees every dip as a buying opportunity may well wind up poorer.

Valuations remain the key.

In these uncertain markets, investors need to find investments that have an underlying business that is not economically sensitive, is a market leader and harbors consistent, sustainable earnings growth witha solid level of income (yield) to cushion the volatile markets. Finally, these types of stocks need to be attractively priced.

One sector that typically falls into this category is health care. If you review the recent market activity, health care were not spared from the carnage, but the downdraft was a little more muted.

One stock that came onto my radar screen is Johnson & Johnson (JNJ).

JNJ is a broad based health care company with exposure to three main business segments: Consumer Healthcare, Pharmaceuticals, and Medical Devices & Diagnostics.

JNJ is propelling its growth through innovative new products and selective acquisitions, all fueled by the winds of a strong demographic trend in its favor.

JNJ is under some competitive pressures from generics and biotech firms in the drug area. The biggest concerns here are an FDA study of Procrit and an apparent higher incidence of cardiac complications and the patent expiration in December 2007 of its schizophrenic drug Risperdal.

JNJ does have an expanding pipeline and expects to file 10 new drug approvals in 2007. In 2006, JNJ acquired Pfizer's consumer brands (Listerine, Rolaids, Sudafed and Benadryl, among others) which adds more high profit margin products to its revenue mix.




On a fundamental basis, JNJ is strong. JNJ generates an enormous amount of cash flow and has a pristine balance sheet with a debt/equity ratio of 17%. JNJ's net profit margins of over 20% result in a 28% ROE for shareholders.

The consensus earnings estimate for JNJ in 2007 is for $3.91 and in 2008 for $4.26. With yesterday's sell-off, JNJ is now selling around 16x this year's and 15x next year's earnings, a slight discount to its peer group.

On a P/S basis, JNJ is also selling at a discount to its peer group. In addition to the 9% growth rate, JNJ has an above average dividend yield of 2.30%. While this is not as high as say a Merck (MRK), it is above the averages for the overall market and consumer product peers.

Probably the most interesting aspect of JNJ's valuation after the sell-off is that JNJ is selling at over a 2% discount to its enterprise value. These are levels rarely seen for a solid, growing company like JNJ. Dividend yields from companies like Merck (3.4%), Abbott Laboratories (ABT) (2.4%) and Eli Lilly (LLY) (3.1%) are slightly higher, but they do not have the growth or attractive valuations that JNJ does.

It may seem more than little late to be offering this warning, but as the dust and smoke clears from yesterday's market detonation, it is imperative that investors not panic. Now is the time to begin to search the rubble for the blue chip stocks that were punished and are now at prices that they rarely see.

Stand back and see the kind of offerings this storm may have brought for your portfolio.



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Tickers in this Article: JNJ, MRK, ABT, LLY

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