Streetwise

Lauren Rudd

Sunday, August 7, 2011

The Most Obvious Investments Are Right Under Your Nose

Peter Lynch wrote in his 1989 best seller, “One Up on Wall Street,” that the Greeks used to sit around and debate how many teeth a horse has. Somehow they thought that was a better method than simply counting the teeth in a sampling of horses.

In a like manner, many investors sit around and debate whether the markets going to rise in price, fall in price, or whether the economy will again fall into a recession, as opposed to actually delving into the nuts and bolts of potential investments.

Lynch also made another important and timeless observation in his book. He pointed out that the most obvious investment opportunities are derived from your own experiences. Even if you are retired, live ten miles from the nearest traffic light, grow your own food and do not have a computer or television, you might one day have to visit a doctor. Hallelujah, welcome to the world of medical products.

I mention this because having just had a second full knee replacement, I am now the proud recipient for the second time of a product manufactured by the Zimmer Corporation, a company I wrote about a year ago. Back then Zimmer (ZMH) and Stryker (SYK), which shared the column, were not exactly setting the world on fire in terms of share performance. Yet, I liked both companies back then and I still do going forward.

To understand why, consider that the number of adults over 65 in the United States is expected to grow to 71 million by 2030. In developing countries the number is projected to reach 690 million.

Both Zimmer and Stryker are well positioned to take advantage of that demographic. Zimmer manufactures orthopedic reconstructive implants, dental reconstructive implants and spinal implants. It also offers surgical products, including supplies and instruments. Stryker is similar, operating in two business segments, orthopedic implants and medical and surgical equipment.

A year ago, my 2010 earnings estimate for Zimmer was $4.25 per share, with a 12-month target price of $57, yielding a 12 percent gain over the price back then of 51.31. It turned out I was a bit light in my projection. Zimmer earned $4.33 per share and the shares recently closed at $57.54.

So how is the company doing this year? Zimmer recently reported second quarter results ended June 30, indicating that net sales increased 7.5 percent to $1,137 million, generating earnings for the quarter of $1.06.

The Company also updated its 2011 revenue and adjusted EPS guidance. Revenues are now expected to increase between 2.5 and 3.5 percent when compared to 2010, while earnings per share are now projected to be in a range of $4.25 to $4.35.

Zimmer’s intrinsic value using a discounted earnings approach with a 10.57 percent growth rate and a 12 percent discount rate is $71 per share, while the more conservative discounted free cash flow to the firm approach yields an intrinsic value of $98. My earnings estimate for this year is $4.60 per share, with a 12-month target price of $66 for a 15 percent capital gain.

A year ago, my 2010 earnings estimate for Stryker was $3.30 per share, with a 12-month target price of $52, yielding a 15 percent gain over the price back then of 46.40. In actuality, Stryker earned $3.33 per share the shares recently closed at $52.07.

For its second quarter ended June 30, Stryker reported a 16.3 percent increase in net sales to $2.05 billion and a 1.3 percent decline in net earnings to $0.80 per share. However, if you exempt acquisition costs, earnings increased to $0.90 per share, a 12.5 percent increase. Guidance for 2011 remains unchanged at an 11 to 13 percent increase in sales, while earnings are projected at $3.65 to $3.73 per share.