Streetwise
Lauren Rudd
Sunday, July 14, 2013
Investment Ideas Come From Personal Experiences
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 actually counting
the teeth in a sampling of horses. In a like manner, many investors are
currently sitting around and debating 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 mention
this because I want to revisit two companies I wrote about in the past and for
which my original interest came about as a result of two knee replacements.
Facing an ankle replacement in August, I am once again drawn to subject of
“replacement.”
Moreover, the adult population 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. The two companies Zimmer (ZMH) and Stryker
(SYK) 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 2012 earnings estimate for Zimmer was $5.25 per
share, with a 12-month target price of $67 for a gain back then of 13.70
percent. So how did the company do? It turns out that I was a bit light in my
earnings projection. Zimmer earned $5.30 per share adjusted and the shares
recently closed at $77.20, well above my forecast.
So how does the future look for Zimmer? In its first quarter
earnings release, Zimmer’s guidance for the year reaffirmed its expectation that
full-year revenues for 2013 will increase between 2.5 percent and 4.5 percent on
a constant currency basis over 2012. (Constant currency eliminates exchange rate
volatility.)
Without the constant currency adjustment Zimmer estimates
revenue growth of between 1.0 and 3.0 percent. Earnings are projected to be in
the range of $5.05 to $5.25 per share on a reported basis and $5.65 to $5.85 on
an adjusted basis.
Adjusted refers to operating performance results that exclude
inventory charges and special one-time items.
Those items include acquisition and integration costs and asset
impairment charges related to prior acquisitions, as well as employee
termination benefits, consulting and professional fees, and certain litigation
matters among others.
Zimmer’s intrinsic value using a discounted earnings approach
with a 9.1 percent growth rate and a 12 percent discount rate is $90 per share.
The more conservative discounted free cash flow to the firm approach yields an
intrinsic value of $118. My earnings estimate for this year is $5.80 per share
adjusted, with a 12-month target price of $86 for a 12 percent capital gain.
There is also an indicated dividend yield of 1.00 percent.
Looking at Stryker, my 2012 earnings estimate was $4.10 per
share with a 12-month target price of $61, for a 17 percent capital gain. In
actuality, Stryker’s earnings were a bit lighter than my estimate, coming in at
$4.07 per share, while the shares recently closed at $66.35, well above my
forecast.
For 2013, Stryker’s guidance calls for constant currency
sales growth in a range of 4.0 to 6.5 percent. Excluding the expected impact of
foreign currency and acquisitions, projected 2013 sales growth is expected to
grow 3.0 to 5.5 percent. Adjusted earnings per share are expected to be in the
range of $4.25 to $4.40.
The intrinsic value of the shares using the discounted earnings approach with an
8.08 percent growth rate and a 12 percent discount rate is $64. The free cash
flow to the firm approach yields an intrinsic value of $108. My earnings
estimate for this year is $4.40 per share, with a 12-month target price of $74
for a 12 percent gain. There is also an indicated dividend yield of 1.60
percent.