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Ted is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
A lot of investors feel safe buying enormous conglomerates that dominate an industry, but few take notice of smaller players that dominate a niche. That’s part of the reason why Stryker Corp (NYSE: SYK) is on sale today at a price that could make investors rich.
Thriving in its Niche
Stryker is very good at inventing and producing orthopedic equipment. It basically expands the niche on its own by creating innovative new products.
The company has a moat in the form of expertise in developing orthopedic equipment; very few firms can match the expertise that Stryker has.
A significant portion of Stryker’s revenue comes from high-quality knees and hips. Unfortunately, Stryker is not the only company in this niche. Zimmer Holdings (NYSE: ZMH) is also a global supplier of knees and hips — though it is only about half the size of Stryker as measured by sales.
In addition, Zimmer is heavily exposed to Europe. The company’s European business has been hit hard by the Euro-zone crisis, which shows no signs of alleviating. As long as Zimmer is still bogged down financially by the poor economic environment in Europe, Stryker should continue to improve relative to its primary competitor.
Stryker has a bright future ahead of it. Its medical equipment segment represents an enormous growth opportunity despite being only a small part of the company today. The company is also continuing to innovate in areas outside of orthopedic equipment, such as its upcoming stroke care toolkit.
Demographics are clearly in Stryker’s favor as the world population ages. But more exciting in my view is the fact that the company has $2.2 billion in cash on its balance sheet. Management has proven to be adept at making value-creating acquisitions to enter new markets — as it did with its January 2013 acquisition of Trauson Holdings to enter the Chinese market. Prudent acquisitions continue to be a major growth driver at the firm.
Competition From Conglomerates
Stryker faces some competition from conglomerates like Johnson Johnson (NYSE: JNJ). JNJ is one of the most recognizable brands in the world, with a diversified set of high quality healthcare businesses that make the company a market leader in most of the spaces in which it competes. It also generates lots of free cash flow from one of the best drug pipelines in the industry.
JNJ has both the cash flow and the know-how to compete with Stryker. Still, Stryker has shown that it can leverage its niche to compete against much larger players in the healthcare sector.
Stryker trades at 18x earnings, which is the same at a 5.5% earnings yield. The company grew EPS at an annual rate of 12% over the last ten years, 6.5% annual rate over the last six years, and a 3% annual rate over the last two years.
It’s not a good sign that EPS growth has been decelerating. But once you factor in the deep recession and Stryker’s future growth opportunities, a few back-of-the-envelope calculations make the stock look pretty appealing:
- 5.5% current yield + 3% growth = 8.5% annual return
- 5.5% current yield + 6.5% growth = 12% annual return
- 5.5% current yield + 12% growth = 17.5% annual return
I do not think that investors who buy today will get a 17.5% annualized return. I think 12% is a stretch for investors to expect, though it is certainly achievable. I think investors can count on a 9% to 10% annualized return over the long run, which is better than the SP 500 will do over the next decade. Therefore, Stryker represents a solid investment opportunity for the enterprising investor.