Streetwise for Sunday May 4, 2008

Streetwise

Lauren Rudd

Sunday, May 4, 2008

Stocks Often Give You A Second Chance

Shortly after the Fed announced its most recent interest rate reduction, the Dow Jones industrial average breached the 13,000 level for the first time since last January. To many, Wall Street was finally on the path to recovery. Unfortunately the euphoria evaporated as quickly as it came about, proving once again that the wiles of Wall Street can be exasperating.

Even more gut wrenching is watching the price of a stock in your portfolio cascade downward after clawing its way upward for one or more years. Investing on Wall Street does call for some emotional fortitude. Yet, any drop in the price of a stock translates to a potential buying opportunity.

Market performers, whose share price has fallen due to overall market trends rather than a specific ailment within the company, often rise again like the proverbial Phoenix. So if you were not fortunate enough to board the train the first time, you may have another chance.

An excellent example is St. Jude Medical. St. Jude manufactures and distributes cardiovascular medical devices. When I wrote about the company a year ago, my earnings estimate for 2007 was $1.76 per share and $2.10 for 2008. Reported GAAP net earnings for 2007 were $1.59 per share. If you exclude one-time charges relating primarily to non-cash items, the adjusted earnings were $1.85 per share. So did St. Jude meet my expectation and is the adjusted number a better determinate of corporate performance.

Adjusted numbers are a two edged sword. If the charges are truly one-time, and in particular are non-cash charges, then yes, the adjusted number does give a more accurate portrayal of performance. The difficulty is that too often companies use adjusted earnings as a way of hiding management blunders. All of which means that you need to dig deeper. Adding to the strength of St. Jude’s position is the increase in free cash flow for 2007, coming in at $$1.64 per share, a five-year high water mark.

Moving ahead to the first quarter of 2008, St. Jude reported net sales of $1.01 billion, an increase of 14 percent. Favorable foreign currency translation comparisons increased first quarter sales by approximately $45 million. This is another factor that should be discounted. Currency translations are exogenous to the company and can work against it as well as for it.

Net earnings for the first quarter of 2008 were $0.53 per share. This compares favorably to the $0.41 per share posted a year ago. Passage of the federal research and development tax credit would increase that to $0.54 per share.

St. Jude is in a highly competitive industry characterized by short product life cycles and volatile fluctuations in market share. At the same time, potential competitors face significant barriers due to the lengthy FDA approval process and the major investments required in both R&D and distribution. Meanwhile, St. Jude’s primary marketplace is expected to grow by about seven percent in 2008, with St Jude likely to well exceed that growth rate.

Revised Medicare reimbursement guidelines calling for an approximate 3 percent reimbursement reduction, as compared an earlier proposal for a cut of up to 23 percent, is also a positive development. For 2008, the company’s gross margin will be approximately 74 percent, with SG&A expenses consuming 36 percent of sales and R&D outlays representing about 12.5 percent.