Studying Stryker (SYK), Part 2

 

In response to the first part of my Studying Stryker post, Michael Healy asked:  << Wondering if you have any insight you could share about how this [a Federal grand jury investigation] will affect what otherwise seems to be a great investment. >>

Last week, on the Better Investing Discussion List (old I-Club-List), Timothy Tsai asked a similar question: << Stryker is the target of a Fed probe. Is this something significant? or is it already factored into the price? >>

 

These questions may seem daunting, but they are not difficult to answer.  Here’s my approach:

 

Full disclosure: I like Stryker a lot, have no special knowledge or insight about its legal problems, and am much more scared about our recessionary market.

 

What I learned about the SYK investigation:

 

- A federal grand jury wants to know if Stryker Biotech, a subsidiary in Mass, illegally promoted and sold two, misbranded bone growth products, and submitted false reports to the FDA.

 

- This info came from a 3-10-09 Reuters.com news item and 3-11-09 S&P Stock Report.  It was almost word-for-word from SYK’s latest 8K report.  S&P added: << We view this news as a troubling expansion of existing investigation, raising corporate governance/oversight concerns. >> 

 

- S&P did not change its 4 star rating or Buy opinion on SYK, but did reduce its target price by $10 to $38 (with SYK selling at $32.12).

 

- Reuters also reported that former employees of Stryker Biotech have pled guilty to charges related to the investigation which began last year.  This was also in SYK’s 8K.  [Maybe the feds think: where there’s smoke, there may be fire?]

 

- Earlier federal probes were noted by S&P: 9-07, SYK agreed to federal oversight of consulting agreements with doctors for 18 months with no financial penalties; 10-07, SEC informal inquiry if SYK illegally sold products in certain foreign countries.

 

- SYK’s latest 10K annual report filed 2-20 with the SEC mentions these legal proceedings, but adds nothing more that I thought was noteworthy.

 

- Value Line has not issued any supplementary report about the investigation or downgraded SYK; Morningstar’s company report pre-dated the 3-10 news; and, although I don’t use them much, there are a bunch of other ratings to check in a week or so (if you’re still worried) to see what, if anything, has changed:

 

** CAPS rating by Motley Fool (5 stars with SYK at $33.81 on 3-13)

** StockScouter rating by MSN Money (9 out of 10 on 3-15)

** Yahoo Finance CGQ ratings (35.1% and 86% as of 3-1)

** Morningstar’s Stewardship Grade (C as of 1-28)

 

- Legal problems, especially lawsuits involving big bucks (like the class actions about cigarette smoking and Rx drugs), can cloud a stock’s price appreciation for an unknown amount of time.  While SYK may be fined, this federal investigation does not involve malfunctioning products or harm to patients.

 

- SYK is a medical device maker and will always be at high risk if and whenever its products don’t work.  Risk-adverse investors should avoid such segments of the stock market.

 

- Investors who do their own SSGs and research should have the confidence to investigate these issues on their own as they involve legal news, not legal questions.  I mean this as positive, encouraging advice.

 

- My sources were: Google Finance (got lots of news on the federal investigation); S&P, VL and Morningstar (free from my local libraries); and the company website (to check what legal stuff was mentioned in the latest 10K and 8K).

 

- Can anyone suggest other, readily available sources to check?

 

 

Armin [revised 3-17-09]

 

Studying Stryker (SYK) and Mulling Over Methods

 

Stryker Corp (SYK) was recently SSGed by Mark Robertson, founder and General Manager of Manifest Investing.com, as part of Better Investing’s First Cut series.  First Cut allows BI members to submit any of their SSGs in PDF format as long as they explain their judgments on a simple three-page form.

 

Mark has a way different way of doing a SSG: he added two years of estimated Sales data in order to change the projection point of EPS growth.  He also estimated SYK’s Pre-Tax Profit Margin two years into the future in order to complete the BI-NAIC Preferred Procedure which is how he estimated EPS for the next 5 years or maybe it was 7 years. <grin>

 

In contrast to Mark, I make SSG judgments and evaluate what’s reasonable by using comparisons.  If you’re interested, see:

 

Determining What’s Reasonable and What’s Not, July 14, 2008 

 

 

Stryker Corp. is a leading manufacturer of orthopedic implant devices (60% of 2007 Sales) and medical/surgical equipment.  It has no long term debt and a remarkable record of EPS growth: over the last 30 years, Value Line says in its 5-30-08 report that Stryker’s EPS has increased by at least 20% in all but one year (1999, due to an acquisition).  I SSGed Stryker last July and it looked super to me.  See: 

Stryker Looks Strong and Solid, July 3, 2008

 

 

SYK’s stock had a tough year in 2008:  Google Finance reports that SYK’s price fell -40% in the last 12 months, -39% in the last 6, and -17% in the last 3.  I try to incorporate such a price decline into my SSGs my making relatively pessimistic judgments as I have no grounds to be rosy in our recessionary market.

 

It was interesting to compare Mark’s “radical” SSG to my conventional one and to the “ultra-conservative” Take Stock. [“my opinion”]  Maybe we will all learn something?

 

STRYKER Corp (SYK)	MarkR from   BI First Cut	Armin-1	Armin-2	Take Stock
Date	1-9-09	6-27-08	1-23-09	1-23-09
Data	S&P	same	same	Hemscott
Price	$40.96	$62.26	$39.44	$40.57
52 week High & Low Price	n/a	n/a	$70.56 & $35.33	n/a
Project Growth From	end of Next  2 Years  [See A]	end of Last Quarter	same	end of Last Annual
Sales Growth	11.00% [See B]	12.00%	same	10.90%
EPS Growth	18.00% [See C]	15.00% [See D]	same [See E]	10.9% initial 08.7% final
High PE	26.0           2008 est [See F]	27.7       from 2006	20.0	30.0
High EPS	$6.50 [See G]	n/a	$5.53	$3.64
High Price	$169.00 $24/sh > VL	$140.40	$110.60	$109.26
Value Line Estimated High Price = $105-145 at $40.83 as of 11-28-08, $110-150 at $67.20 as of 8-29-08, $110-145 at $68.54 as of 5-30-08 and 2-29-08
Low PE	14.0           2008 est	19.7        from 2006	14.1	20.6
Low EPS	$2.88	n/a	$2.75       (TTM actual)	$2.59
Low Price	$32.00 (60% of cur price)	$49.60 (low PE x low EPS)	$21.20      (60% of 52 week low)	$53.35   [See H]
Upside/Down	14.3      [See  I]	6.2	3.9	impossible to compute
Projected Annual Return	26.6%	n/a	22.3%	n/a
Total Return	33.2%	17.9%	23.3%	22.4%
SSG Buy Under	n/a	$70.53	$43.55	$55.76
RV/PRV (no outs)	60.3/52.8	n/a	49.3/43.0	n/a
Quality	n/a	S&P = A+ tops	same	TS = 6.3 good
	2005-2009	2003-2007	2003-2007	2003-2007
PTPM – 5 yr ave	23.0% trend up	20.7% trend up	same	21.0% trend n/a
ROE – 5 yr ave End Equity	19.9% trend even	20.3% trend down	20.8%  same	n/a
ROE – 5 yr ave Start Equity	n/a	26.1% trend down	same	25.8% trend n/a
Debt to Equity – 5 yr ave	n/a	01.3% trend down	same	n/a

 

DISCUSSION:

 

[A] Mark relied on YahooFinance to get Sales estimates for the next 2 years (in dollars) which he entered into his Toolkit software to “fool” the program into projecting growth from the end of those two years.  The last year of actual data was 2007, Mark added estimated data for 2008 & 2009, and projected growth for the next five years 2010-2014.

 

[B] Mark’s 11.00% Sales growth estimate was based on adding two years of estimated Sales data, eliminating the first five years as outliers, and “truncating” the remaining five year result of 11.90% to 11.00%. <Whew>

 

- The Toolkit software can act only on 10 years of data so adding two years means the earliest two years are discarded.  Then, Mark eliminated the first five years as outliers in order to ascertain more recent trends based on 3 years actual and 2 years of estimated Sales data.

 

- I think Mark’s “truncating” meant reducing, not rounding, from 11.90% to 11.00%.  But, and it’s a big “but”, why not truncate or reduce to 10.00% or less: Stryker’s historical Sales growth has been trending down, with 2007 the lowest growth in the past 10 years at 11.00%.

 [C] Mark derived his 18.00% estimated EPS by using BI-NAIC’s Preferred Procedure which involves making four estimates for the next 5 years (2010-2014 for Mark).  His PDF file did not set forth his PP estimates, but I was able to duplicate his 18.00% estimate by using: 11.00% Sales growth (which Mark decided); 29.9% estimated Pre-Tax Profit Margin (28-30% PTPM was mentioned in his write-up); 27.8% estimated Taxes (from Value Line); and 360 M estimated Shares (also from Value Line).

- Even the low end of Mark’ estimated 28-30% PTPM is much higher than Stryker’s actual PTPM and his Preferred Procedure would have dropped substantially from 18.00% to 12.20% if he had used the last year of Stryker’s actual PTPM; to 11.30% with SYK’s last two year average PTPM; or to 10.80% with SYK’s last three year average PTPM.

- Here’s my tally of Mark’s SSG so far: two years of estimated Sales data from YahooFinance, three years of actual data from S&P, two estimates from Value Line, none of which are for 2010-2014, but which is the period that Mark used to project his estimated 18.00% EPS growth.

 

[D] My method of estimating EPS for the next 5 years is much more straight-forward than Mark’s.  When I did my earlier SSG, the six analysts I check for every SSG were closely estimating long-term EPS at around 18-18.50% with Value Line low at 17.50% and FactSet CallStreet high at 20.00%.  S&P was 18.50%, Reuters via Morningstar was 18.70%, Zacks.com was 18.88%, and FirstCall via YahooFinance was 19.00%. 

- All of these EPS estimates are for the next 5 years except VL’s which is for the next 3-5 years.  Note that they are from six different sources, not just six different websites.  Only by surveying all of them can I tell which is out-of-whack and which is in the ballpark.

[E] When I updated my SSG on 1-23-09, the average of the estimates by the same six analysts had dropped to 17.75%.  FactSet and Value Line were unchanged, FirstCall via YahooFinance was now the lowest and down to 15.85% (from 19.00%), S&P was down to 18.00% (from 18.50%), Zacks was down slightly to 18.29% (from 18.88%), and Reuters was up slightly to 18.80% (from 18.70%).

 

- I usually rely on the lowest EPS estimate of the six or the average less one Standard Deviation (which Excel calculates for me) as I believe this appropriately “wrings out” any analyst over-optimism and provides a reasonably conservative result.  Here, the lowest estimate was First Call’s 15.85% and the average of the six less 1 SD was 16.35%.

- Keep in mind that Mark’s 18.00% estimated EPS, which is based in part on two years of estimated Sales data from YahooFinance, [1] ignored YahooFinance’s five year EPS estimate of 15.85% (down from 19.00%) and [2] exceeded two other estimates, from Zacks and Reuters.

- Unlike Mark, I don’t use the Preferred Procedure as it involves too many estimates and too much guesswork for me.  For example, which PP seems most appropriate for Stryker: Mark’s 18.00% based on 28-30% PTPM; 12.20% if he had used 23.2% PTPM from Stryker’s last year of actual data; 11.30% if he had used 22.3% PTPM from SYK’s last two year average; or 10.80% if he had used 21.8% PTPM from SYK’s last three year average?  If you’re still interested in the PP, you might want to check out:

Considering Kohls and Reconsidering NAIC’s Preferred Procedure

 

[F] Mark’s Forecast High PE of 26.0 is his estimate for 2008 as is his Forecast Low PE of 14.1.  He doesn’t explain how he made these estimates, but I’m guessing he “interpolated” them from the latest Value Line report.

[G] Mark’s $6.50 estimated High EPS is central to his SSG.  He wrote: “The EPS growth rate is “force calculated” and will display as 14% based on erroneous handling.  What is important for the [High] price forecast is the 5-year EPS forecast ($6.50, from interpolation) and the PE selections in [SSG] Section 4.” [my emphasis and insertion]

- Sadly, I do not know what Mark meant by “force calculated”, or “interpolate”, and he did not clarify.  When I use his 18.00% estimated EPS, after adding two years of estimated data like he did, my Toolkit software calculates $7.68 as the High EPS (not $6.50).  And when I work backwards using his $6.50 High EPS, my TK software calculates 14.2% EPS which is erroneous according to Mark.  How he “force calculated” 18.00% to produce $6.50 High EPS is a mystery.

- Of fundamental importance is that a conventional SSG with 18.80% EPS (virtually the same as Mark’s 18.00%) results in $6.50 High EPS (exactly the same as Mark’s $6.50) without adding two years of estimated Sales data for 2008-2009, without estimating PTPM at 28-30% and thereby substantially exceeding actual trends, without projecting growth from 2010-2014 when 2007 is the last year of actual data, and without any “force calculation”, interpolation, slight-of-hand, or hocus pocus.

 [H] Take Stock is not programmed to recognize when it exceeds or is very close to the current price.  Its Forecast Low Price of $53.51 in the next five years is way over Stryker’s current price of $40.57. That’s another SSG no-no and explains why it is impossible to calculate Take Stock’s Upside/Downside Ratio.  That’s not an inadvertent flaw, but a deliberate design feature, and Take Stock produces an-almost-but-not-quite SSG.

On the other hand, Mark’s Forecast Low Price was based on 60% of SYK’s current price while mine was based on 60% of SYK’s 52 week low price because Stryker’s price has fallen so much this past year.  

[I] The SSG criteria to consider buying any stock are a minimum 3.0 Upside/Downside Ratio and a 15.0% Total Compound Annual Return each year for the next 5 years.  Mark’s SSG with a 14.3 U/D and 33.2% TR does not indicate a better “Buy” than my 4.1 U/D and 23.3% as both of our SSGs satisfy the minimum requirements.

- I’m always wary of double digit U/Ds or sky-high TRs as overly-optimistic, and especially suspicious when both occur in the same SSG.  The BI-NAIC Stock Selection Handbook warns: “When you see a large upside-downside ratio, revisit your judgment in [SSG] Section 3 and the forecast low price” (page 112, 2003).

CONCLUSIONS:

(1) A conventional SSG is preferable, I think, to analyze Stryker and most growth stocks, and it seems unnecessary as well as bewildering to add two years (or even one) of estimated data, to project growth from 2010 to 2014 (when the last year of actual data is 2007), and to rely on a Pre-Tax Profit Margin estimated seven years into the future that substantially exceeds the stock’s recent trends.

(2) When I SSGed Stryker last June, it satisfied the SSG Buy criteria.  Seven months laster, when I SSGed SYK again, it continues to look strong and solid.

Let me know what you think by leaving a comment here and I’m going to invite Mark to share his thoughts.

 

- Armin

 

Stryker (SYK): Looking Strong and Solid

 

Stryker Corp (SYK) is a major manufacturer of orthopedic implants (60% of 2007 sales) and medical-surgical equipment.  It has a remarkable record of EPS growth: over the past 30 years, the company’s EPS has increased by at least 20% in all but one year (1999, due to an acquisition) according to Value Line.  When I use S&P data, its EPS has averaged nearly 26% per year over the last 10 years.  However, growth has declined in the last 3 years to around 18% annually and Sales growth has also slowed to 11-12% during the same time. 

 

Despite the downtrend, the company’s Pre-Tax Profit Margin is trending up, a positive development, going from around 18% five years ago to 23% in 2007 (for a five-year average of about 21%).  According to Reuters.com, Stryker’s PTPM is almost twice as large as its industry average.  Moreover, SYK has virtually no debt, some $17.7M which is only .3% of Total Capital.

 

Morningstar especially likes the company’s “top-tier” position in the orthopedic implant market, particularly with regard to knees and trauma as well as spine products and SYK plans to launch two artificial spinal discs by 2010.  Its hip segment hasn’t done as well, primarily because of a product recall in early 2008.  The FDA sent a stern six-page warning letter in January ordering SYK to fix a host of long-standing manufacturing problems with its hip replacement parts.

 

The Investment Advisory Service chose Stryker as one of its featured stocks in July.  IAS is a pay service by investment professionals who use the SSG to analyze stocks.  Ann Cuneaz, Better Investing’s Education Program Manager, also recently SSGed Stryker.  Her analysis is available on the First Cut page of the BI website.

 

Here is a comparison of the SSG by IAS, Ann, myself and Take Stock.  Take Stock is a computerized program that is designed to produce a conservative result without input from the user.  I did two SSGs, one with S&P data and the other with Hemscott data, but both with the same judgments.

 

Stryker   Corp (SYK)	IAS	Ann Cuneaz		Armin-1	Armin-2	Take Stock
Date	6-16-08	6-26-08		6-27-08	6-27-08	6-27-08
Data	S&P	S&P		S&P	Hemscott	Hemscott
Price	$64.54	$62.00		$62.26	Same	$62.54
Sales Growth	13.00%	12.00%		12.00%	Same	10.90%
EPS Growth	17.00%	12.00%		15.00%	Same	08.71%
Forecast High PE	30.0	28.0		27.7 (2006 low)	26.7 (2006 low)	30.0
Forecast High Price	$157.80 (8.8% > VL)	$124.30		$140.40	$135.10	$109.26
Value Line Estimated High Price = $110-145 on 2-25-08 and 5-30-08
Forecast Low PE	20.0	18.0		19.7 (2006 low)	20.3 (2006 low)	20.6
Forecast Low Price	$48.00 (Low PE x Low EPS)	$45.40 (Low PE x Low EPS)		$49.60 (Low PE x Low EPS)	$51.50 (Low PE x Low EPS	$50.68
Upside/Down	5.6	3.8		6.2	6.6	3.9 (imputed)
Total Return	19.9%	15.4%		17.9%	17.0%	12.6%
A SSG Buy at	$75.45	N/A		$70.53	$67.84	$55.59
Rel Value & Projected RV	89.9% & 78.1%	84.8% & 75.7%		85.2% & 74.1%	85.8% & 74.3%	N/A
Quality	S&P = B +	N/A		S&P = A+	No Rating	TS = 6.3, acceptable
PTPM – 5 yr ave	19.1% Trend up		20.7% Trend up	20.7% Trend up	19.1% Trend up	21.0% Trend N/A
ROE – 5 yr ave End Equity	20.4% Trend down		20.3% Trend down	20.3% Trend down	20.1% Trend down	N/A
ROE -5 yr ave Start Equity	26.1% Trend down		N/A	26.1% Trend down	25.8% Trend down	25.8% Trend N/A
Debt : Equity 5 yr ave	-0- Trend even		N/A	1.3% Trend down	1.3% Trend down	N/A

 

- Morningstar recently raised its Sales Growth estimate for SYK from 12 to 13% for the next 5 years.  Zacks is also estimating 13.45% Sales Growth for the next 5 years.  IAS, Ann and I were all near these estimates.

 

- When I did my SSG, six sets of analysts were closely estimating long-term EPS at around 18-18.50% with Value Line low at 17.50% and First Call high at 20.00%.  S&P was 18.50%, Reuters via Morningstar was 18.70%, Zacks was 18.88%, and First Call was 19.00%.  First Call’s seven estimates ranged from a low of 13.00% to a high of 20.00%; at Zacks, the eight estimates ranged from a low of 15.00% to a high of 20.00%.

 

- I use comparisons to assess what I think is reasonable and I do not rely on my gut feelings (or how well I sleep at night). The analyst estimates ranged from 13.0% to 20.0% and anything within that range I define as acceptable.  For SYK, more than 20.0% seems too high and less than 13.0% seems too low.

 

- My 15.00% EPS estimate is 5.00% lower than the highest estimate (First Call) and 2.50% lower than the lowest (Value Line).  More importantly to me, now that Reuters.com has stopped reporting the Standard Deviation of its analyst estimates, is that my Forecast High Price is squarely within Value Line’s High Price estimate.  This combination tells me that my judgments are reasonably conservative, not too high and not too low.

 

- Take Stock’s EPS estimate seems unreasonably low at 8.71%, nearly 9.0% below the lowest estimate which was VL at 17.50%.  It’s no surprise, then, that Take Stock is the only analysis that did not result in a SSG Buy with a 12.6% Total Return (15% minimum required). 

 

- Take Stock gave Stryker a Quality Rating of 6.3: a minimum of 3.4 is required to pass muster, 6.7 is desired and 10.0 is the maximum.  In contrast, S&P gave Stryker an A+ for Quality, its highest of 8 ratings.

 

- IAS explicitly said it was using conservative judgments: 30 for its Forecast High PE instead of 34, the average High PE for the past 5 years, and 20 for its Forecast Low PE instead of the 24.3 average Low PE.  IAS also said its 17.0% estimated EPS was conservative compared to the 20.0% that the analysts were estimating, but I found 20.0% by only the very highest analyst at First Call.  Still, IAS’s estimate of 17.0% is less than the 18.0-18.5% consensus I discovered.

 

- However, IAS’s so-called conservative judgments produced a Forecast High Price that was almost 9% higher than the high end of Value Line’s Estimated High Price.  That’s high, but not outrageously or unreasonably high, but neither is it conservative.

 

- Ann said her 12.0% EPS estimate was “validated” by her Preferred Procedure (PP), but when I used her judgments in my PP, I got 13.9% which was closer to my 15.0% estimate than to her 12.0%.  If Ann had used 13.9%, her SSG would have resulted in 5.7 Upside/Downside Ratio (instead of her 3.8 U/D) and a 16.8% Total Return (instead of 15.4%).  I don’t understand the point of using the PP only to ignore it and then arbitrarily lower the EPS estimate by an unsupported amount.

 

-  The PP involves making four estimates for the next 5 years: Sales Growth, Pre-Tax Profit Margin, Tax Rate and Shares Outstanding.  I don’t use the PP because it involves too many estimates and too much guesswork for me.  For example, the default PP with my 12% Sales growth estimate results in 9.5% EPS growth; with VL’s estimated Shares Outstanding and estimated Tax Rate, it increases to 13.1%; and when I also use the last three year average for PTPM (instead of the default’s last 5 year average), I get 14.3%.  So, which is more fitting: 9.5%, 13.1%, or 14.3%?

 

- My “preferred procedure” <joke> is to survey all the analyst EPS estimates and decide what is reasonably conservative: not too high and not too low.

 

- Three different methods were used to decide the Forecast High and Low PEs.  IAS limited its forecast to a pre-determined maximum (30.0 High PE and 20.0 Low) which no stock, no matter what, could exceed; Ann chose SYK’s lowest PEs in the last 10 years (28.0 High and 18.0 Low); and I picked the lowest PEs in the last 5 years (27.7 High and 19.7 Low).

 

- SYK’s direct competitors (not industry peers) are Medtronics (MDT), Zimmer Holdings (ZMH), and DePuy, a subsidiary of JNJ.  The Online SSG at the BI website now allows users to pick up to three peer companies, but provides no advice on which companies are peers nor does it define the peer group.

 

Armin