Observing O’Reilly (ORLY)

O’Reilly Automotive (ORLY) is a large chain of retail stores in the U.S. that sell auto parts and after-market accessories.  As of June 30^th, ORLY had just over 3600 stores.

O’Reilly was the subject of the monthly Online Stock Study at the BI website for November 2011 and was led by Adam Ritt, editor of the Better Investing magazine.  ORLY’s Value Line and Morningstar reports are available to BI members as are Adam’s Presentation Slides, an audio recording of the online study, and an earlier SSG and report by the Investment Advisory Service (IAS).

The Online Stock Study uses consensus decision-making to complete a SSG in about one hour.  Happily, and for the first time in almost a year, the Consensus SSG is also available as a handout.  Hooray!!

 Company Background:

– O’Reilly’s Sales & EPS growth has been impressive: 19.3% & 16.5% for the past 10 years; up to 26.8% & 17.1% over the last 5; and up again to 22.8% & 41.5% for the last 3 years. 

 – The company’s acquisition of CSK Auto in 2008 increased its store base by 70% as well as its geographical presence in the West, especially California.

 – ORLY’s sales reflected 59% Do-It-Yourself (walk-in customers) and 48% Do-It-For-Me (repair shops) as of June 2011; before the CSK acquisition, 52% were Do-It-Yourselfers.

– The company began in 1957 with one store and Wikipedia as well as IAS reported that much of ORLY’s growth has been fueled by acquisition:

** In 1998, it merged with Hi/Lo Auto Supply adding 190 stores; in 2000, it bought KarPro Auto Parts and its 14 stores; in 2001, it purchased Mid-State Auto Distributors adding 85 stores; and in 2008, it bought CSK with 1342 stores, its largest acquisition.

– ORLY’s 2010 Annual Report explained that the company opened 149 net new stores last year, counting openings and closings, and plans to open 170 in 2011.

** Same Store Sales increased from 4.6% to 8.8% in 2010.

 ** The company also opened three new distribution centers last year, relocated one, and converted another.

** ORLY anticipates “significant market share gains in the Western U.S.” in the next several years and expects to make some $50M capital investment in the acquired CSK stores.

– ORLY’s direct competitors are Auto Zone (AZO), Advance Auto Parts (AAP), and Genuine Parts (GPC) according to YahooFinance.

** Among these competitors over the last 5 years, ORLY had the highest average Sales growth, AAP had the highest EPS growth, and AZO had the highest Pre-Tax Profit Margin;

** Morningstar reported that ORLY faced stiff competition from AZO and AAP which also have been aggressively expanding;

** Because there is little product differentiation among its competitors and low barriers to entry, Mstar assigned no economic moat to ORLY (no competitive advantage).

SSG Discussion:

– The following table compares the Consensus SSG with recent SSGs by Adam (from BI’s First Cut), myself, and Take Stock. 

– After the table, I discuss key judgment issues, ORLY’s Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE), and its Financial Condition.

O’Reilly Auto-       motive (ORLY)	Consensus SSG	AdamR      (from BI’s  First Cut)	ArminF	Take Stock
Date	11-1-11	Same	10-28-11	10-31-11
Data	Mstar via BI	Same	Same	Mstar via SC
Price	$76.45	$78.79	$76.07	Same
52 week High &   Low Price	$77.35 & $53.33	$78.77 &   Same	Same &       Same	Not Used
Last Quarter of     Reported Data	Q3 ending    9-30-11	Same	Same	Same
Software Used	Online SSG	Same	TK 6	TS Online
Project Growth     From End of	Last Q	Same	Same	Last FY
Sales Growth	7.00%	8.00%	15.00%	11.00%
EPS Growth	8.00%	8.00%	15.00%	11.40% start 06.69% end
High PE	18.4	22.0	20.3	21.5
High EPS	$5.39	$5.14	$7.04	$4.45
High Price	$99.18	$113.00	$142.90       (10% > VL)	$95.75
VL Estimated High Price = $95-130 as of 9-5-11 and 11-14-11
Low PE	14.81	Same	12.3	12.6
Low EPS	$3.50	Same	Same	$3.20
Low Price	$51.84	Same	$43.10	$40.32
Upside/Downside Ratio	0.92	1.28	2.0	Impossible to Calculate
Total Return	3.2%	3.75	13.4%	4.7%
SSG Buy Under	Not Available	Same	$68.05	$47.87
RV/PRV	Not Available	Same	Not Used	Not                Available
RV/PRV (no outs)	Not Available	Same	117.9/102.7	Not                Available
Quality	Not Used	Same	S&P = B+     (4th of 8 grades)	TS = 3.2 unacceptable
PTPM – 5 yr ave	11.21%      Trend N/A	Same          Same	11.20%       Trend up	Same             Trend N/A
ROE – 5 yr ave      End Year Equity	11.62%      Trend N/A	Same          Same	11.60%        Trend up	Not Used
ROE – 5 yr ave     Begin Year Equity	Not Available	Same	13.6%         Trend up	14.0%          Trend N/A
Debt to Equity –   5 yr ave	Not Available	Same	16.8%        Trend down	Not Used

The Consensus SSG:

(A) Estimating Future Sales Growth for the next 5 years

– Adam gave the participants four options to estimate ORLY’s future Sales growth: 7.00%, analyst estimates (unnamed) for this year and next; 8.00%, estimate by Morningstar and Value Line, and 3Q actual; 12.00%, Investor’s Advisory Service estimate in January 2011; and 19.00%, ORLY’s long-term historic growth.

** The only website I know of that makes a Sales growth estimate for the next 5 years is Zacks.com;

** Value Line’s 7.00% estimate was for Sales per Share, not Sales, and VL makes no estimate of future Sales;

** ORLY’s historic Sales growth of 19.00% was for the last 10 years and its Sales growth for the last 5 years increased to 23.80%.

– The Consensus (60% of the votes) chose 8.00%; the next highest vote (22%) was for 7.00%.  

(B) Estimating Future EPS Growth

– The participants were given four choices to estimate the company’s future EPS growth: Same as their estimated Sales growth; 8.00%, imputed rate from VL’s dollar estimate from 2011 to 2014-2016; 13.50%, VL’s estimated rate from its Annual Rates box; 15.00%, IAS estimate in January 2011; and 16.50%, ORLY’s long-term historic EPS growth.

** ORLY’s historic EPS growth of 16.50% was for the last 10 years; its EPS growth for the last 5 years increased slightly to 17.1%.

** It’s a mistake, I believe, to impute a rate from VL dollar amounts that’s different from its Annual Rates box as VL uses a unique method to calculate its rates which is explained in a new page [click here].

– The Consensus (52%) chose 9.00%, Adam’s imputed VL rate; the next highest vote (28%) was for 13.5%, VL’s estimate for the next 3-5 years from its Annual Rates box.

Adam‘s SSG:

Estimating Future EPS Growth:

– Adam limited his EPS growth to 8.00%, the same as his Sales growth estimate.

– He then used the NAIC/BI Preferred Procedure to double check his judgment and used these four inputs: Sales growth = 8.00%; PTPM = 12.5% (average of 2006, 07 & 10); 37.5% Tax Rate (from VL); and 133M Shares Outstanding.

– His PP reslted in 7% EPS growth for the next 5 years which Adam thought was a “little low” so he used 8.00% even though he mentioned that unnamed analysts were estimating 16.5%-17.0%.

 Armin’s SSG:

Estimating Future EPS Growth:

– When I did my SSG, the seven long-term EPS estimates I ALWAYS check were averaging 16.4% with CNNMoney via FactSet CallStreet high at 18.00% and VL low at 13.50%. 

 ** Relying on VL without checking other estimates is unwise, as demonstrated by the Online Stock Study, since it may be atypically low;

** Morningstar.com and Zacks via BI were both 17.00%; Yahoo Finance via Thomson/FirstCall was 16.50%; Reuters.com was 16.49%; and Zacks.com was 16.05%;

** For how I estimate EPS growth for all my SSGs, see: Estimating EPS [click here].

– I decided to estimate 15.00% EPS growth which, together with my Estimated High PE, gave me a Forecast High Price that was 10% greater than VL’s estimate as I try to never exceed VL by a substantial amount.

Final Results:

– None of the four analyses resulted in a SSG Buy, maybe because ORLY’s price was close to its 52 week high.

FINAL RESULTS	Consensus SSG	AdamR	ArminF	Take Stock
SSG Date	11-1-11	11-10-11	10-28-11	10-31-11
Price when SSG was done	$76.45	$78.79	$76.07	Same
52 week High &            Low Price	$77.35 & $53.33	$78.99 & Same	Same & Same	Not Used
EPS Growth	9.00%	8.00%	15.00%	6.49%
Forecast High PE	18.4	22.0	20.3	21.5
Forecast High Price	$99.18	$113.08	$142.90 (10% >VL)	$95.75
Upside-Downside Ratio (need 3.0 min to Buy)	0.92	1.28	2.0	Impossible to Calculate
Expected Total Return (need 15% min to Buy)	3.2%	3.75%	13.4%	4.7%
FINAL RESULTS	DON’T BUY	DON’T BUY	DON’T BUY	DON’T BUY

– The Consensus SSG began with a low EPS estimate as well as a low Forecast High PE and resulted in the lowest Total Return;

– My SSG began with a substantially higher EPS estimate but still failed to satisfy the BUY criteria (3.0 U/D and 15% TR).

 Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE):

– PTPM and ROE 5 year averages are both trending up which are good signs and what we want to see from all our SSGs.

– Morningstar places ORLY in the Specialty Retail Industry which is a hodge-podge of companies that sell different things.

– ORLY’s PTPM is substantially better than its Industry Average (11.2% vs 5.79%) and its ROE is also better (11.6% vs 9.87%);

** I no longer pay for a subscription to Stock Central because the only thing I used was its Industry Data (which is the best on the web).

** Now, I use the meagre Industry data at the BI webite which does not provide a company-by-company breakdown so I can no longer identify and eliminate atypical amounts, and recalulate the adjusted average.

Financial Condition:

– Value Line gave ORLY an “A” for Financial Strength, its third highest of nine ratings:

** VL also reported that the company’s cash had increased from $29.7 M in 2010 to $268.8 M eighteen months later.

– Morningstar found that ORLY was in “good financial health”:

** Moreover, the company can “easily service its debt” using internally generated cash flows; and

** Earnings before Interest and Taxes were a comfortable 10 times Interest expenses over the past 5 years and Mstar expects that rate to improve in the future.

– The Annual Report Spreadsheet by Bob Adams gave ORLY’s 2010 A.R. a 73 out of 100 with 9 Bullish results (good things) and 9 Bearish (not-so-goods):

** The Bullish results included: sales are increasing and increasing faster than related costs; debt is decreasing and interest coverage is reasonable; debt to equity at 11.1% is reasonable.

** The Bearish results included: ROE at 13.1% is inadequate and gets a yellow caution flag; Accounts Receivable, Inventories, and Shares outstanding are all increasing and all get a yellow caution flag.

– My SSG shows that ORLY’s Long-Term Debt went from a low of $75.1 M in 2007 to a high of $724.6 M in 2008 and then down to $357.3 M in 2010, the last full year of available data.

** Currently, ORLY’s Total Debt is $797.8 M, its Debt to Total Capital is 20.7%, and its Cash Flow per Share is $2.38 (after being negative three of the last 5 years).

 

Armin

**** ORLY is my 85th post to this SSG Blog which I expect to end soon after 5 years.  It’s a lot of work with very little reward (feedback).  

 

Admiring Apple (AAPL)

– Apple Inc (AAPL) makes the Macintosh personal computer, iPod music player, iPhone smart cell phone and, two months ago, began selling its iPad device (a book reader/web surfing tablet). 

– These products are all elegantly designed, sold in Apple retail stores that are fun to shop in and buzz with excitement, and the company has the CEO of the Decade, according to Fortune magazine, Steve Jobs. 

– AAPL was the Online Stock Study in May at the Better Investing website that was led by Mike Torbenson, education director at the BI Puget Sound chapter.  

** Mike’s presentation slides, the recorded webinar (78 mins), the latest 10K and 10Q reports, and the Value Line report are all available to BI members. 

Company Background: 

S&P Stock Report: 

 – S&P reported AAPL’s CY 2009 sales as: 35% Macintosh computers (11 Million units shipped), 26% iPhones, 20% iPods (over 25 Million sold), and 10% music related. 

Mike’s Presentation: 

– In the last 15 months (1/09 to 3/10), AAPL’s price rose 350%, from $78 per share to $272. 

– In 2009, revenue by product grew (or declined)  as follows: iPod down (-2.5%), Mac up 7%, and iPhone up a whopping 93%.

** AAPL has 11% of the smart-phone market with NOK at 41% and RIM at 20% which Mike thought left lots of room for growth. 

– The iPad was introduced in April 2010 and sold 1 million units faster than the iPhone.  The iPad is now in the “early adopters” phase of growth with lots more room to grow. 

Fortune magazine’s CEO of the Decade: 

– In the past 10 years, Fortune wrote, Steve Jobs “has radically and lucratively reordered three markets — music, movies, and mobile telephones — and his impact on his original industry, computing, has only grown.”   

– In addition, he has “creat[ed] more than $150 billion in shareholder wealth….and profoundly influenc[ed] the worlds of retail and design.” 

– AAPL was worth about $5 billion in 2000, according to Fortune, just before Jobs implemented its “digital lifestyle” strategy, and today, at about $170 billion, it is slightly more valuable than GOOG. 

The New York Times: 

 – On May 26, the Times reported that AAPL had passed MSFT to become the world’s most valuable technology company.   

– Calling it the end of one era and the beginning of the next, the Times profoundly realized that the “most important technology product no longer sits on your desk but rather fits in your hand.” 

– On May 30, the Times reported that the iPad had sold 2 million devices in less than two months,  an average of 35,000 per day since its April debut. 

 Value Line: 

– VL was so impressed with AAPL’s growth prospects that it raised its EPS estimate by 40.00% for this year (FY 2010). 

– VL also thought that Apple’s long-term prospects looked “exceptionally bright.” 

Morningstar: 

– In April, Mstar raised its fair value estimate from $202 to $238 (with AAPL selling at $263.95) to reflect the iPad’s initial success. 

– Still, the star of Apple’s show, according to Morningstar, remains the iPhone given its large global market and infrastructure (175,000 apps and growing). 

SSG Discussion: 

– The following table compares SSGs by Mike (found only in the webinar recording) with mine, the Investment Advisory Service, and with Take Stock.  

** After the table, I discuss AAPL’s quality and several key SSG judgments as well as its financial condition.

Apple Inc                   (AAPL)	MikeT	ArminF	Take Stock	Investment Advisory Service (IAS)
Date	4-20-10	5-11-10	Same	3-10-10
Data	S&P	Same	Morningstar-Hemscott	S&P
Price	$270.83	$258.08	Same	$224.84
52 week High &          Low Price	$272.18 & $119.38	$272.46 & $119.38	Not Used	$224.48 & $89.58
Last Quarter of     Reported Data	Q2 ending       3-31-10	Same	Same	Q1 ending      12-31-09
Software Used	TK 6	Same	TS Online	TK6
Project Growth      From End of	Last Quarter	Same	Last FY	Last Quarter
Sales Growth	15.00%	17.00%	12.20%	17.00%
EPS Growth	15.00%             (PP)	17.00%	12.20% initial 08.23% final	17.00%
High PE	25.0	20.8                  (from 2009)	30.0	25.0
High EPS	$23.69	$25.83	$9.34	$19.91
High Price	$592.30           (20% > VL on 4-9-10)	$537.30           (8.5% > VL on 4-9-10)	$280.24         (23% < VL on    4-9-10)	$497.70          (8.2% > VL on 1-8-10)
Value Line Estimated High Price = $365-495 on  4-9-10 and $305-460 on 1-8-10
Low PE	16.0	9.5	13.1	15.0
Low EPS	$11.78	Same	$6.66	$9.08
Low Price	$125.90            (PVQ option)	$111.90             (Low PE x      Low EPS)	$87.25               (Same)	$136.20
Upside/Down	2.2	1.9	0.13                    (imputed)	3.1
Total Return	16.9%	15.8%	2.0%	17.1%
SSG Buy Under	N/A	$218.25	$135.50	N/A
RV/PRV                       (no outliers)	90.6/78.7	86.2/73.7	Not Used	96.6/73.9
Quality	N/A	S&P = B	TS = 6.3	IAS = 1.0
PTPM – 5 yr ave	19.6%                Trend up	19.6%                Same	18.3%                   Trend N/A	19/6%               Trend up
ROE – 5 yr ave         Ending Year Equity	N/A	21.5%               Trend up	Not Used	N/A
ROE – 5 yr ave          Begin Year Equity	30.4%            Trend up	Same                  Same	28.4%                   Trend N/A	30.4%               Trend up
Debt to Equity –       5 yr ave	-0-                      Trend even	Same                Same	Same                     Same	Same                Same

Quality:

– Before beginning his SSG, Mike evaluated whether AAPL was a quality company by looking at its past performance in SSG Sections #1 and #2.

** For historical Sales and EPS, he found that the last 5 years looked very good and the results from the most recent quarter (Sales up 49%, EPS up 86%) were excellent.

**  For historical Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE), he saw that the last 5 years were trending up and looked good while AAPL’s zero debt looked very good. 

** Mike also compared APPL to other technology companies and to its Value Line industry (Computer and Peripherals), and concluded that Apple was a quality growth company.

– A typical BI/NAIC approach to quality is to assess whether the graph lines in Section #1 are up (growth), straight and parallel (consistency) and also whether the trends in Sections #2A  and #2B are up or even.  

– And, S&P rates AAPL a B for Quality, 5^th out of eight grades, while IAS rates its Quality a 1 out of 5, most favorable.

Mike’s SSG:

Estimating Future Sales and EPS Growth:  

– Mike looked at several indicators to estimate Apple’s future Sales growth: its last 5 years growth (31.9%); VL’s 3-5 year estimate (15.5%); its last quarter’s growth (48.6%); and TTM Sales growth (40.7%). 

** Mike thought 15-20% seemed justified, so he chose 15.00% (presentation slides, PDF pages 24 & 25). 

** Value Line’s 15.5% estimate was actually for Sales per Share and VL does not make a Sales growth estimate. 

** 12.00% was Morningstar’s long-term Sales growth estimate and 28.17% was Zacks.com’s. 

– To estimate future EPS growth, Mike used the Preferred Procedure (PP) which involves making four other estimates for the next 5 years: Sales Growth, Pre-Tax Profit Margin, Taxes, and Shares Outstanding. 

** Relying on his 15.00% Sales growth estimate, he changed only one of the defaults: PTPM from its five-year average of 19.6% to last year’s 28.0%, a huge increase of nearly 8.5%. 

** His PP came to 15.40% EPS which he rounded to 15.00% to match his Sales estimate. 

** Instead of estimating 28.0% for the next 5 years, his PP would have been considerably different had Mike used 21.0% PTPM (last 2-year average), or 23.4% (last 3-year average).   

** Moreover, Mike could have also used VL’s estimated Taxes of 30.0% (instead of the default 31.7%), or VL’s estimated Shares Outstanding of 975.0M (instead of the default 969.6M). 

### I no longer use the PP because it involves too many estimates and too much guesswork for me: see Pondering The Preferred Procedure 

Armin’s SSG: 

Estimating Future EPS Growth: 

– When I did my SSG, the SEVEN analysts I ALWAYS check were estimating long-term EPS at an average of 18.85% with Value Line high at 23.00% and Yahoo Finance via Thomson Financial low at 17.10%. 

– Reuters.com was 17.69%, Zacks.com and CNNMoney via FactSet CallStreet were both 18.00%, Morningstar.com was 18.20%, and S&P via BI was 20.00%.  Reuters 11 analysts ranged from a high of 30.0% to a low of 5.00%. 

– I decided to use 17.00%, the lowest estimate (rounded) of the seven. 

### To learn more about Estimating EPS, click here.  

Forecasting the High and Low PEs: 

– Even though 2009 was unusually low (and well below the five-year average of 34.8), I chose to use its 20.8 as my Forecast High PE. 

– I thought 2009’s Low PE of 8.6 was too low to use for the next 5 years, so I used 9.5 for my Forecast Low PE which was proportional to my Forecast High PE (5 year average High PE / 5 year average Low PE = Forecast High PE / Forecast Low PE or “X”). 

Take Stock: 

– TS initially estimated 12.2% based on AAPL’s historic growth, but reduced that to 8.23% EPS by mechanically applying its version of the Preferred Procedure. 

– TS also used 30.0 as its Forecast High PE, the maximum it is designed to permit. 

Investment Advisory Service: 

– IAS is a pay service from IClubCentral which delivers three SSGs each month that satisfy the BUY criteria along with an explanatory narrative.  Its AAPL SSG was made available for free (but without the narrative explanation) at the StockCentral website.  

– IAS used 17.00% estimated EPS (which seems reasonable to me since I used the same value <grin>) and 25.0 & 15.0 Forecast High & Low PEs) which seem moderately conservative since 30.0 & 20.0 are often used as maximum limits. 

Final Results: 

– Of the four studies, only IAS satisfied the SSG Buy Criteria in March, but today, or even 3-4 weeks ago, its SSG would not: 

• Mike got a 2.2 U/D (min 3.0 required) and a 16.9% TR with a Forecast High Price that was 20% greater than VL’s estimate;
• I got a 1.8% U/D and a 15.8% TR with a Forecast High Price that was 8.5% greater than VL’s estimate;
• Take Stock got a .13 imputed U/D and a 2.0% TR with a Forecast High Price that was 23% less than VL’s estimate; and
• IAS got a 3.1 U/D and a 17.1% TR (last March when AAPL was selling for $224.84) with a Forecast High Price that was 8.2% greater than VL’s January estimate. 
• However, IAS’s SSG would not satisfy the Buy criteria at the price I used ($258.08) or at AAPL’s current price ($263.95 on 6/3).                                                             

– I analyzed Apple some 30 months ago (on 1/18/08) when it was selling for $171.25 per share and, unlike now, it was then not close to a SSG Buy; if you’re interested, click here. 

  Financial Condition: 

– Value Line gave Apple an A++ for Financial Strength, its highest grade.  The company had no debt and $2.5 billion of cash assets as of 12-26-09. 

– Morningstar found that Apple had a cash “hoard” of $34 Billion and an annual cash flow of almost $10 Billion which means, Mstar believed, almost unlimited financial flexibility. 

– The Bob Adams one-click Annual Report spreadsheet gave Apple a 60 out of 100 with 11 Bullish and 7 Bearish results: 

** The Bullish-good things include: no debt; sales are increasing and increasing faster than related costs; ROE gets a green flag (excellent); and free cash flow margin is also excellent. 

** The Bearish-not-so-goods include: accounts receivable are increasing; cash flow growth is not increasing as fast as sales growth; and the price to sales ratio gets the only red flag (danger). 

### Bob just updated his spreadsheet and the latest version is No. 4.14, dated 5-22-10. 

### You can get this super-duper, easy to use spreadsheet for free, along with an explanation of its many features, by going to my Favorite Links page: click here. 

 Armin 

 [your feedback is important so please rate this post on the mouse-over scale below and/or leave a comment.] 

 

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