Johnson & Johnson

I sold candy at religious school on Tuesdays and Thursdays because the kids were starving after school. I would buy it up over the weekend and bring it to school and sell it for an arbitrage profit. So it was just a pattern of being drawn to small business and making money, and over time that led to an interest in the stock market. My first stock was some bar mitzvah money when I was around 10 years old. [12:03] BARRY RITHOLTZ: Well, it can’t have been bar mitzvah money. [12:05] SETH KLARMAN: It wasn’t bar mitzvah money then, it was a present, but then bar mitzvah money continued to be. So really, 10 years old, and about a share of Johnson & Johnson. [12:14] BARRY RITHOLTZ: Still have it? [12:15] SETH KLARMAN: Do not still have it. It’s split three for one, but ultimately I presumably have traded that in for something else that I like better. [12:23] BARRY RITHOLTZ: So let’s fast forward a little bit to the Baupost origin story, which isn’t that far ahead. You’re only 25. The urban legend is you co-founded Baupost, but in reality you were brought in to manage money for the four founding families — still at 25. That’s a kind of shocking thing: “Oh, we have all this wealth, let’s bring in this kid to run our portfolio.” [12:51] SETH KLARMAN: Right. And I would say the same thing. If I were in their seats, I would wonder, how does this kid know how to do that?

The weighted average free cash flow (‘FCF’) yield (the free cash flow generated as a percentage of the market value) of the portfolio at the outset of the year was 2.7% and ended it at 3.2%. The year-end median FCF yield on the S&P 500 was 3.4%, roughly in line with our portfolio. This is one benefit of the fall in share prices over the period. Our portfolio consists of companies that are fundamentally a lot better than the average of those in either index and are valued fractionally higher than the average S&P 500 company. Turning to the third leg of our strategy, which we succinctly describe as ‘Do nothing’, minimising portfolio turnover remains one of our objectives and this was again achieved with a portfolio turnover of 7.4% during the period, a little higher than usual. It is perhaps more helpful to know that we spent a total of just 0.003% (less than a third of a basis point) of the Fund’s average value over the year on voluntary dealing (which excludes dealing costs associated with subscriptions and redemptions as these are involuntary). We sold our stakes in Johnson & Johnson, Starbucks, Kone, Intuit and PayPal and purchased stakes in Mettler-Toledo, Adobe, Otis and Apple.some

company based on ESG factors and current “hot topics”. At the end of December 2020, the weighted average RepRisk indicator for our portfolio was 25.8, higher than it was at the start of the year but still well below the S&P 500 index score of 29.1. At the end of 2020, the four companies with the highest RepRisk Indicator scores were: Microsoft (54) Johnson & Johnson (53) Unilever (49) Visa (49) Microsoft’s and Johnson & Johnson have switched positions in this year’s ranking despite the RepRisk Indicator of both falling from 57 to 54 and from 58 to 53 respectively. Unilever has kept its position at third, although its score has increased from 46 to 49. Visa, replacing Marriott, is a new and somewhat questionable entrant into the list. It’s RepRisk increased by 15 in December after news it was suspending the use of its cards on Mindgeek’s site Pornhub, amid allegations of rape scenes, child abuse and private videos being shown on the website without participants’ consent. This is something that we would consider a positive impact, which reduces the investment risk of Visa. At the end of 2020, the four companies with the lowest RepRisk Indicator scores were: Kone (0) IDEXX (0) Waters (1) Undisclosed Position (4) Kone and IDEXX (which also appeared last year) are an elevator & escalator business and animal diagnostic testing business respectively, and therefore have unsurprisingly low scores.

It overly simplifies something to the point that its meaning is lost. There is no way for anyone to quantify how much “better” it is for society for Johnson & Johnson to actually be producing a COVID vaccine compared to PayPal helping small businesses reopen faster. This is why we report the good and the bad which FSEF portfolio companies do each month in the commentary on our FSEF ESG factsheet so that you and we can assess particular instances. Over time we find that these tend to give us a clear picture of a company’s stance on sustainability, but it is one based upon informed judgment rather than box ticking or spurious precision. We also, rather than relying on external rating providers, perform our own analysis of both the positive and negative impacts our portfolio companies have in the widest possible sense, accepting that in many cases the impact isn’t going to be tangible. In contrast, the majority of the asset management industry rely on external rating providers to simplify their assessment of what they can and can’t invest in.

One of the key metrics we use to assess ESG risk is RepRisk data which provides a measure of the current reputational risk for each company based on ESG factors and current “hot topics”. At the end of December 2019, the weighted average RepRisk indicator for our portfolio was 21.9, slightly higher than it was at the start of the year but substantially below the S&P 500 index score of 29.3. At the end of 2019 the four companies with the highest RepRisk Indicator scores were: 1. Johnson & Johnson 58 2. Microsoft 57 3. Unilever 46 4. Marriott International 41 Marriott International dropped from 2nd to 4th following no further significant negative news after the data leak at Starwood in December 2018. Microsoft replaced PepsiCo in the list and its RepRisk indicator score rose due to issues surrounding tax planning by technology businesses and using its strong market position against smaller competitors, both negative impacts we don’t assign much weight to as these are part of what makes it a good investment.&

For the companies in our investable universe that don’t report environmental stats, we have always estimated them by looking at the average per £m of assets for the company’s respective subsector for each environmental stat we report and then scaling that number up for the assets of the individual company. From March, we also started doing this for the S&P 500 environmental stats to give a more accurate comparison for our portfolio. Johnson & Johnson (J&J) has consistently had the highest RepRisk indicator (RRI) of any company in the portfolio since we launched the Fundsmith Sustainable Equity Fund. It started the year with an RRI of 66 and finished it with a slightly lower score of 58. The majority of that score comes from the risk associated with the safety of their products, whether J&J accurately represented those risks and publicity from US court cases and settlements. When a company has a high RRI it can be, but isn’t always, an indicator that the company has a large negative impact on the environment or society. However, it can also indicate there has been a lot of media coverage around a specific story where the headlines and the details tell different stories. J&J’s lawsuits, which are the main driver of its high RRI score, mainly relate to whether it misrepresented the safety of its products in its marketing.

The list looks very similar to that of 2017 with the highest scorer from last year, Nestlé, being replaced this year in the list by Marriott. Nestlé was sold from the FSEF portfolio during 2018, while Marriott’s RepRisk indicator increased by 28 in December after the data leak from its Starwood brand. Johnson & Johnson’s RepRisk indicator has increased from 53 to 65 as its medical subsidiary, Ethicon, has been widely criticised for the risks involved in transvaginal mesh implants, which caused chronic and excruciating pain for thousands of woman and has also been subject to extensive litigation and punitive damages awarded to patients who developed mesothelioma, a deadly form of cancer caused by exposure to asbestos-contaminated talcum powder between 1972 and 2003. At the end of 2018 the four companies with the lowest RepRisk scores were: IDEXX 0 Intertek 0 Sage 0 Waters 0 This list also looks very similar to end 2017, with the only change being CR Bard, which was taken over by Becton Dickinson, being replaced by Sage. A noticeable trend over 2018 has been the increasing number of companies commenting on their efforts to improve the recyclability of packaging and in particular plastics — especially since Sir David Attenborough highlighted the impact plastic waste can have on the oceans at the end of the television series Blue Planet II.

For the year, the top five contributors to the Fund’s performance were: IDEXX Laboratories +3.10% Stryker +2.54% CR Bard +2.06% InterContinental Hotels +1.71% Johnson & Johnson +1.68% The bottom five were: Estée Lauder - 0.06% Procter & Gamble - 0.02% Novo Nordisk +0.07% Colgate Palmolive +0.23% Imperial Brands +0.37% The largest contributor, IDEXX, is a company which we began buying in 2015. It is the world’s largest maker of veterinary testing equipment. In contrast, we have held stakes in Stryker, InterContinental Hotels and Johnson & Johnson since inception. Of the bottom five performers we sold our stake in Procter & Gamble in January 2016. You may note that out of the five worst contributors to our performance last year, four were consumer stocks and at least three are regularly cited as “bond proxies”. It seems strange to be accused of having benefitted from the popularity of these stocks when in fact they have underperformed. We only recently began buying stakes in Estée Lauder, the US cosmetics business and even more recently in Novo Nordisk, a Danish company, which is the world’s leading supplier of insulins. Turning to the third leg of our strategy which we succinctly describe as “do nothing”, minimising portfolio turnover remains one of our objectives and this was again achieved with a portfolio turnover of -15.6%* during the period.

In order to reduce their pension costs, companies have increasingly replaced traditional Defined Benefit (DB) retirement plans with Defined Contribution (DC) thrift plans, which are now the dominant form of retirement planning in the U.S. But most workers lack the specialized knowledge and experience needed to successfully manage their own investments. In 2012, New York Times columnist Joe Nocera wrote a piece in which he described how the losses in his high-risk-oriented retirement plan, plus his later divorce, depleted his retirement account to the point where there is no way he can retire. He concluded, “most human beings lack the skill and emotional wherewithal to be good investors. Linking investing and retirement has turned out to be a recipe for disaster.” 8 My longtime friend and neighbor, James Mackie, read my op-ed and, without any assistance, took it upon himself to have that resolution inserted into the proxy statement of Johnson & Johnson. Management opposed, and the resolution failed to pass. But Jim continues his work again this year. I believe that this harbinger of shareholder democracy has great potential to serve society.

[27:15] This may be a reason to research a stock. The fact a stock is $3 down from $100 doesn’t mean you should buy it. And in fact, short sellers, people who really make money in stocks, they don’t short Walmart. They don’t short Home Depot. They don’t short the great companies, Johnson & Johnson. They short stocks down from $80 to $7. They’d like to short it at $16 or $22, but they figured out at $7, this company is going to zero. They just haven’t blown taps on this thing yet. It’s going to zero, and they’re selling short at $7. They’re selling short at $6, at $5, at $4, at $3, at $2, at $1.25. And you know to sell something short, you need a buyer. Somebody has to buy the damn thing! You wonder who’s buying this thing. The buyers are people saying, “It’s $3. How much lower can it go?”