By Tom Bradley

In recent years I’ve had the pleasure of getting to know Danny Bubis, President and Chief Investment Officer of Winnipeg-based Tetrem Capital Management (anyone from my home town is a great person). Tetrem manages private and institutional money and became much better known in 2006 when Danny took over management of the gynormous CI Canadian Investment fund.

In his most recent letter to clients Danny uses Johnson & Johnson (JNJ) to illustrate the merits of investing in high-quality, dividend-paying stocks as opposed to government bonds. JNJ has a AAA credit rating and a diversified revenue base. It has increased its dividend for 48 consecutive years and trades at a below-average valuation.

I thought the following part of the letter was particularly good at pointing out the valuation anomalies in the markets today:

“Smart corporate treasurers and CFOs are taking advantage of 50-years-low bond yields to create even more value. For instance, Johnson & Johnson recently issued 10-year debt at 2.95% (clearly the bond market doesn’t see much risk in JNJ). The arbitrage opportunity is huge: issue debt where the interest is deductible against earnings and use the proceeds to buy back shares. Saving the non-deductible dividend payment for each of the retired shares. The accelerated buyback will also be accretive to earnings per share growth, which eventually should lead to a higher valuation.”

As Danny points out, JNJ is the ‘poster child’ for blue chip, global companies, but there are many others that are trading at reasonable valuations and continue to build on their strengths.

It strikes me, however, that the JNJs of the world would be even better off if money wasn’t so cheap right now. Government stimulation and low rates are keeping weaker players alive. The strong companies are getting stronger, but they’d make more gains in a less artificial economic environment where the cyclical excesses are allowed to correct themselves naturally.