Streetwise

Lauren Rudd

Sunday, August 5, 2012

Use Your Own Experience

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

In a like manner, many investors sit around and debate whether the markets are going higher or lower, as opposed to actually “counting the teeth” of potential investments.

Lynch made another observation. He pointed out that investment opportunities are often derived from your own experiences. I am going to expand on that a bit and say they can also be derived from the experiences of others. And in a retirement area such as my home town of Sarasota, Florida, you can bet conversations will often turn to medical procedures.

I mention this because I want to revisit two companies I have written about in the past and for which I have received requests for an update. My initial interest in these two companies came about as a result of my own knee replacements and conversations I have had with doctors and other patients.

Zimmer Corporation (ZMH) and Stryker (SYK) were not exactly setting the world on fire in terms of share performance when I discussed them a year ago. Yet, I liked both companies back then and I still do going forward.

One key reason is that the number of adults over 65 in the United States is forecasted 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 2011 earnings estimate for Zimmer was $4.60 per share, with a 12-month target price of $66 for a 15 percent capital gain. It turned out I was a bit light in my earnings projection. Zimmer earned $4.80 per share and yet the shares recently closed at $58.93. In my defense, the shares were just shy of $65 as recently as July 18.

So how is the company doing today? For the second quarter ended June 30, revenue fell slightly and GAAP earnings per share grew significantly.

Zimmer booked revenue of $1.13 billion against a consensus estimate of $1.14 billion, or about 1.1 percent lower than a year prior. However, margins improved across the board as earnings, excluding one-time charges, came in at $1.34 per share, against a consensus estimate of $1.32. GAAP earnings were $1.22 per share, a 15 percent increase over the prior-year quarter's $1.06 per share.

Zimmer’s intrinsic value using a discounted earnings approach with a 9.6 percent growth rate and a 15 percent discount rate is $71 per share. The more conservative discounted free cash flow to the firm approach yields an intrinsic value of $133. My earnings estimate for this year is $5.25 per share, with a 12-month target price of $67 for a 13.70 percent gain. There is also an indicated dividend yield of 1.20 percent.

A year ago, my 2010 earnings estimate for Stryker was $3.74 per share, with a 12-month target price of $61, for a 15 percent capital gain. In actuality, Stryker earned $3.72 per share and the shares recently closed at $52.03. Again, the shares were over $55 at the end of June.

For its second quarter ended June 30, net revenue rose 2.9 percent to $2.1 billion, about in line with analysts' estimates. Excluding one-time charges, Stryker earned 98 cents per share against a consensus estimate of 99 cents. GAAP earnings were 85 cents per share, as compared to 79 cents a year ago.