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J&J: Secrets of Success

Johnson & Johnson doesn't seek the spotlight, but its extraordinary track record - and how it pulls that off - is a wonder to behold.

By Geoff Colvin and Jessica Shambora
April 22, 2009: 5:46 AM ET

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"We have all this expertise in-house so we can draw on it rather than having to go out and find somebody."
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Diverse products from across all its businesses (including artificial knees, center) help keep customers healthy.

(Fortune Magazine) -- Are you having a tough year at your company? Sorry to hear it. If it makes you feel any better, they're also having a tough year at Johnson & Johnson.

How tough? Well, it appears - though it's not certain - that sales may actually decline in 2009, and that hasn't happened in 76 years. Profits will probably decline too, which hasn't happened in 25 years. But don't worry about the dividend. The company will almost certainly manage to raise it this year, just as it has done annually for the past 46 years.

Okay, that probably doesn't make you feel any better. Those facts show the extent of the damage at J&J during the economic collapse, and if it seems laughably mild, then you're beginning to see why this company is worth much more attention than it usually gets. J&J (JNJ, Fortune 500) doesn't make a lot of noise. It doesn't seek media attention and rarely gets major headlines. Its advertising focuses on its famous brands - Band-Aids, Tylenol, Splenda - that don't include the J&J name. The company is easy to overlook, yet in these desperate times its extraordinary performance demands closer scrutiny than ever.

To see just how well J&J performs, first check its stats in the new Fortune 500. Last year - 12 solid months of economic decline in the U.S. - the company's sales rose 4.3%, and it jumped six places in the 500 ranking, to No. 29. Though the 500's profits dropped 85% last year, J&J's profit increased 22%. That made J&J the sixth-most-profitable company in the Fortune 500 and the fifth most valuable, ahead of Procter & Gamble, Berkshire Hathaway, Chevron, IBM, General Electric, and many other famously great performers.

As remarkable as that record seems, you get a more impressive perspective by stepping back - way back. Not many companies can give you their 100-year compound annual growth rate, but J&J can. It's 10.5%, and that's not coming off some tiny startup's base revenues, since the company was already 23 years old a century ago. Nor is the company a typical lumbering giant that grew like a sprout in its early years and then leveled off; it actually grew faster in the recent 50 years than in the previous 50.

As for the measure that most people really care about: The stock has been a marvel. It beat the market easily last year, but again, the longer view is even more impressive. If you'd bought a single share when the company went public in 1944 at its IPO price of $37.50 and had reinvested the dividends, you'd now have a bit over $900,000, a stunning annual return of 17.1%. Even if you hadn't reinvested the dividends, that single share would now be 2,500 shares as a result of splits, and you'd be collecting dividends of $4,500 a year from that $37.50 investment. If only Grandpa had bought 100 shares.

Of course, nothing guarantees that this extremely rare record of standout performance will continue. The company faces major risks. Highly lucrative drugs are going off patent, and pinched consumers could switch from J&J's premium branded products to less expensive generics. Any maker of drugs and medical devices faces the danger of devastating lawsuits. Giant-scale national health-care reform, if it happens, could hurt the company. Citigroup analyst Matt Dodds says 2009 "will be J&J's most challenging year in a decade."

Yet investors don't seem much worried by any of that. The share price indicates that they figure J&J will most likely keep performing in line with its record. All of which makes you wonder what lessons other businesses can learn from this outfit. As always with extraordinary performance, the explanation isn't any one thing. Instead, it's a matter of remaining faithful to several imperatives simultaneously - in this case, five of them.

1) Diversify within a single industry.

"We're not really a conglomerate," says CFO Dominic Caruso, but J&J isn't really not one, and the balance it has struck turns out to be important. The company is organized into three major groups. Consumer products includes not just famed J&J items like Johnson's baby shampoo and Tylenol but also Nicorette anti-smoking gum, Listerine mouthwash (both acquired when J&J bought Pfizer's consumer business in 2006), Neutrogena skin-care products, and dozens of other brands.

The medical devices and diagnostics group supplies operating rooms and doctors' offices with a wide range of products including sutures, blood tests, endosurgery tools, and artificial joints like the high-tech knee in CEO Bill Weldon's right leg. The pharmaceuticals business sells prescription drugs that include Concerta for attention deficit disorder, Remicade for arthritis, Prezista for HIV/AIDS, and many others. Though the consumer business is best known, it's the smallest of the three.

All three groups are obviously in the health-care industry - that's why J&J isn't exactly a conglomerate - yet their furthest corners are clearly unrelated. The portfolio works because it captures benefits from both worlds. Its diversification reduces risk. This year the company expects that its strong devices and diagnostics business will help buffer against the expiration of two key patents in the pharma group - a loss of about $2.9 billion, reckons Citigroup's Dodds.

At the same time, J&J realizes benefits by staying within one broadly defined industry. For example, a meeting between engineers from the devices group and scientists from the pharma group led to a groundbreaking discovery: The tiny metal stents used to open blocked arteries could be coated with a drug to prevent the artery from narrowing again. The resulting drug-eluting Cypher stent, though controversial, has brought more than $10 billion in sales since its 2002 launch.

2) Focus on the future.

Managers everywhere complain that investors are obsessed with the short term and will punish any company that even thinks of sacrificing today for tomorrow. J&J's experience suggests otherwise - that investors are happy to let a company bet on the future if they believe it can win. Citigroup's Dodds says R&D spending within the pharmaceutical business, though down slightly from recent years, is "still the highest number in Big Pharma."

Even before products reach the development pipeline, an internal think tank - the Corporate Office of Science and Technology (COSAT) - is looking way ahead, seeking the next big idea. "They're going across the landscape looking at this really early stuff, trying to identify the opportunities out there," explains Weldon. "It may be a decade before they bring value."

J&J is also extremely conservative. Robert Wood Johnson, the visionary CEO who took the company public, insisted that "reserves must be created" and "adverse times must be provided for." That's why J&J borrows little and won't even go near endangering its triple-A credit rating. Says Leerink-Swan analyst Rick Wise: "They're thinking 10 or 20 years out. They have the financial flexibility and staying power so that even when they make a mistake short-term, they have the ability to hang in there."

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