Better Buy: Verizon Communications Inc. vs. Johnson & Johnson

By Brian Stoffel Markets Fool.com

Dividends aren't sexy but they are effective. While companies that offer regular payouts aren't likely to triple in value in any given year, dividends are the strong and steady force behind many retirement portfolios.

Continue Reading Below

Over time, such payments create dynamic wealth. Consider the two companies we are investigating today: telecom giant Verizon (NYSE: VZ) and healthcare conglomerate Johnson & Johnson (NYSE: JNJ). Over the last 25 years, their stocks have gone up 130% and 940%, respectively. But when we take dividends into account, this is what happens.

VZ Total Return Price data by YCharts.

While Johnson & Johnson's returns are obviously better, it's worth noting that an investor's returns on Verizon more than quadruple thanks to the dividend.But the question for today is: Which is the better stock moving forward? That's impossible to answer with 100% certainty, but we can get a better idea for what we're buying by investigating three key variables.

Sustainable competitive advantages

Continue Reading Below

If I had my way, I'd jump into a time machine, grab my beginner investor self, and tell him, "Brian, there's nothing more important to your success than picking companies with the strongest sustainable competitive advantages."

That's because these advantages, often referred to as "moats," are what separate a companies from the rest of the field. They provide that special something that keeps customers coming back for more and the competition at bay for ages.

Image source: Getty Images.

Johnson & Johnson has three different divisions, each with its own moat. The consumer division, which accounts for 18% of sales, is buoyed by the strength of the company's brands like Band-Aid and Tylenol. The medical device division -- which comprises 35% of all sales -- benefits from large installed bases and moderately high switching costs for hospitals. And biggest of all, pharmaceuticals -- pulling in 47% of all sales -- is protected by patents.

It's somewhat concerning that patents only last a specific amount of time, and yet they protect almost half of the company's revenue.At the same time, the reliability of the other two divisions allows Johnson & Johnson some leeway that other pharmaceutical companies don't have.

On the other hand, Verizon is protected by two moats. First, the barriers to entry in the telecom industry are very high: It takes billions to build out a reliable network before you collect your first dime in revenue. There are four major players that control the majority of the wireless telecom market, with Verizon as top dog, pulling in 35% of that market -- according to Statista.

Verizon is also making inroads into becoming a content company. The acquisitions of AOL and part of Yahoo!are evidence of this.

If this seems like a lot of ink spilled over the moats for these two, that's because it is. It's impossible for me to solidly declare a winner here, as both are very strong.

Winner = Tie

Financial fortitude

Investors love seeing cash returned to them. But it's important to keep cash sitting in the bank, too. That's because every company will deal with tough economic times. When those times hit, companies with cash have options: buy back shares on the cheap, acquire competitors, or outspend them in an attempt to gain market share.

Those with a lot of debt are in the opposite boat, fragilized by their tenuous obligations. In the chart below, I've adjusted Verizon's free cash flow numbers to normalize them. They were artificially lower due to the fact that the company paid a large one-time tax bill for divesting some of its business, and it changed its business model to do far less subsidizing of phone plans.

Remember that Johnson & Johnson is valued 70% higher than Verizon. Here's how the two stack up:

Company

Cash

Debt

Net Income

Free Cash Flow

Verizon

$4 billion

$105 billion

$13.1 billion

$13.8 billion

Johnson & Johnson

$42 billion

$22 billion

$16.5 billion

$15.5 billion

Data source: Yahoo! Finance, SEC filings.

Both companies have very strong cash flow, which is a very positive sign. But the difference on the balance sheet is market. Verizon has one-10th the cash on hand and five times the debt. Although Johnson & Johnson has already announced that it's going to be using some of that cash on acquisitions, it still is in a much stronger position.

Winner = Johnson & Johnson

Valuation

Finally, we have valuation. While this isn't an exact science, there are some straightforward metrics we can consult to give us an idea of how expensive each stock is.

Company

P/E

P/FCF

PEG Ratio

Dividend

FCF Payout

Verizon

13

14

3.0

4.8%

67%*

Johnson & Johnson

19

22

2.7

2.6%

55%

Data source: Yahoo! Finance, E*Trade. P/E represents figures from non-GAAP earnings. *FCF for Verizon is adjusted for the factors mentioned above.

On the face of it, Johnson & Johnson appears to be the more expensive stock, trading at a significant premium on an earnings and free cash flow basis. But the company is growing faster than Verizon as well, and trades at a 10% discount to Verizon on the PEG ratio.

In the end, the differentiator is the dividend. Verizon's payout is safe and much larger than Johnson & Johnson's.

Winner = Verizon

The winner is...

So there you have it: We have a draw. Both companies have solid moats, Johnson & Johnson has the stronger balance sheet, and Verizon is more attractively valued. If I were forced to choose, I would side with Johnson & Johnson, as I like the company's opportunities to grow in the future, while I think Verizon's foray into content is a bit riskier.

Either way, both of these companies are solid dividend payers worthy of your careful consideration.

10 stocks we like better than Johnson & Johnson
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Johnson & Johnson wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of April 3, 2017

Brian Stoffel has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Johnson & Johnson and Verizon Communications. The Motley Fool recommends Yahoo. The Motley Fool has a disclosure policy.