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Dear Mr. Berko: I am considering the purchase of 100 shares of Stryker and Johnson & Johnson for my 401(k) account. My broker believes both can increase their share value by 50 percent in the next year. And both issues are way down from their high prices. Please advise.

R.E.
San Antonio

Dear R.E.: That broker has a case of 鈥渋gnis fatuus鈥� and probably drives a Zamboni to the office. However, because knee bones are connected to thigh bones, thigh bones are connected to hip bones, and hip bones are connected to back bones, this connectivity is starting to show wear, especially in the bones belonging to the millions of baby boomers who are starting to sign up for Medicare.

Stryker (SYK-$42.67) is a $6.7 billion revenue company. Sixty percent of those revenues come from its work designing, producing and selling orthopedic implants, hips, knees, spinal and craniomaxillofacial implants. Stryker also makes the tools that attach joints to joints and bone to bone, and also markets specialty stretchers, maternity beds and other operating room devices from which it derives 40 percent of its revenues. Stryker has been one of the darlings of Wall Street for more than a decade, posting double-digit gains in revenues and earnings between 1993 and 2008.

However, it seems that our economic collapse might have disjointed that remarkable record, and patients are delaying expensive elective surgeries. Growing unemployment could continue to dampen Stryker鈥檚 revenues.

Meanwhile, analysts believe hospital spending, which has declined about 20 percent this year, will pick up 4 percent to 7 percent in 2010. Wall Street also believes that implant procedures will begin to increase in the last quarter of 2009 and improve dramatically in 2010. If so, Stryker could move to the low $50s. But if not, and this is my belief, then Stryker could trade in the $33 to $35 range.

Stryker has $2.3 billion in cash, no debt, cash flow in excess of $1 billion, a 19-percent return on equity, net-profit margins of 17.4 percent, and not a single share of preferred stock outstanding. These are important numbers because this balance sheet will help Stryker survive President Barack Obama鈥檚 health care reform that will crimp profits, and obscure long-term performance estimates and future planning. This is a great company, but sales and earnings growth are dependent on a significant improvement in employment. I don鈥檛 see that happening for a while. Do not buy the stock, which is down from its 52-week high price of $74.

Johnson & Johnson (JNJ-$61.05) has traded in a narrow 10-point to 12-point range during the past half-dozen years even though revenues grew 50 percent while earnings, dividends and book value doubled. In that same time frame, operating margins remained at a solid 20 percent, net-profit margins held at a healthy 19 percent and return on shareholder equity remained steady at 28 percent. This suggests that Johnson & Johnson shares might have been too highly priced for the past several years.

This is the world鈥檚 largest health care product company. It had $63.4 billion in 2008 revenues, and this year could be the first in the more than 100 years of Johnson & Johnson that revenues will decline. The company鈥檚 prescription drug sales are losing ground to generics, and anemia drug Procrit appears to have some safety issues. Johnson & Johnson鈥檚 drug-coated stent is losing sales to rivals, smaller hospital budgets are crimping institutional revenues and tighter consumer thrift has dampened retail sales. Plus, private-label brands have lowered over-the-counter revenues, including Johnson & Johnson鈥檚 highly profitable and impressive sales of wound-care products.

I see no reason for Johnson & Johnson to trade in the high $70s in the coming year. And though the company has enjoyed an average profit-to-earnings ratio of about 19 during the last decade, I think a ratio of 12 to 13 is now more likely. So, with expected earnings of $4.55 this year, the stock seems fairly priced at $54-$57; I wouldn鈥檛 buy it.

Address your financial questions to Malcolm Berko, c/o The Daily Journal of Commerce, P.O. Box 8303, Largo, FL 33775, or e-mail him at [email protected].
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