STJ

It’s that time of the year again … a time when most people indulge in expressions of love and affection for others. While some are in, or looking to be in, long-term relationships, others are looking for short-term romance. Similarly, some investors look for long-term investment opportunities, while others look for short-term gains. This blog will look at the medical device industry to find companies that have exposure to heart-related products and are making good strategic decisions. We wrote previously about how important it is to understand Management Quality with two important variables: Economic Management and Asset Growth. The Management Quality Quadrant below looks at a few companies that market their medical devices to treat irregular heartbeats, repair heart valves, and otherwise help patients with serious heart conditions.

Every year, The Applied Finance Group (AFG) hosts a client conference centered around detailed valuation sessions, product training, stock picks, and forecasts on where AFG believes the market will be over the course of the next year. One of the most prized pieces of information that comes from AFG’s Research Summit is a product called “10 stocks to buy on Monday (10STBOM).” The implication is that every one of the 10 names we provide in this list is well researched companies by our analysts and we would recommend them as buy opportunities when you return to the office from AFG’s conference on Monday. As with any stock selection that AFG delivers, the stock selection begins with valuation and ultimately ends with valuation.

Below is the performance of our 10 Stocks to Buy on Monday portfolios from 2004 to 2008 in which alpha was added to the respected benchmarks every year. Below is an example of one of the stocks that made it to our list this year, St. Jude Medical (STJ). For more information regarding AFG’s 10 STBOM or other research services AFG provides, sign up for a free trial at www.EconomicMargin.com.

10 Stocks to Buy is a portfolio released each year at AFG's annual conference, which looks to outperform the Russell 1000 and Russell 2000 indices. This portfolio contains 10 Large Cap and 10 Small Cap buy ideas across major economic sectors.

 

The Applied Finance Group

STJ Investment Summary: Target Recommendation: St. Jude Medical is a global manufacturer of cardiovascular and implantable neurostimulation medical devices. STJ operates in four segments, which are all experiencing growth while its closest peers are challenged with sales declines. The company’s main products include implantable cardioverter defribillators (ICDs), pacemakers, and heart valve replacement products to help patients who suffer from life-threatening heart conditions. In addition, the company also offers products designed to aid physicians in diagnosing and treating irregular heartbeats, including implantable heart monitors, and neurostimulation devices that deliver electrical impulses to treat chronic pain sufferers. St. Jude has been able to achieve volume growth in each segment, driven by successful penetration in domestic and international geographies and market share capture as competitors in key markets face safety related product recalls. We believe that St. Jude has one of the best heart-related product offerings in the medical device industry. We recommend STJ shares as a large cap health care holding with a $51 target, or 25% upside. Recent Events: •STJ expects to spend 12% -13% of sales on R&D, one of the highest in the industry. The company remains committed to investing in its new product pipeline to drive long-term growth. •On May 6, STJ announced that it launched Attune, an adjustable ring used in surgical procedures for the repair of diseased heart valves after receiving FDA approval. •On May 11, the FDA approved STJ’s Current Plus ICD and Promote Plus cardiac resynchronization therapy defibrillator (CRT-D) devices for treating life-threatening arrhythmias and heart failure. •On May 11, STJ announced that it received European approval for PromoteAccel CRT-D for patients suffering from heart failure.

 

The Applied Finance Group’s (AFG’s) Economic Margin (EM) methodology helps investors understand what a company earns above its true cost of capital or how profitable a firm is. Companies expected to improve their Economic Margins have proven to be more likely to outperform than companies with expected EM declines. The table below provides 10 stocks expected to improve their Economic Margins in the next fiscal year and look attractive from a valuation perspective according to AFG’s valuation model. All 10 of these firms also currently have a default buy recommendation and look to have considerable long-term upside.

S&P 500 - Stocks to Watch (ex. Financials)

 

AFG's default valuation is a great place to start when looking for potential equity investments as our valuation techniques have proven successful through time at identifying mispriced securities and helping our clients identify investment opportunities resulting in outperforming their chosen benchmark.

AFG's Valuation Model – Using AFG’s modified discounted cash flow model to measure the intrinsic value of a firm compared to its peers. AFG's Value Score - A score which represents the ranked percent to target (deviation between stock’s current trading price and AFG’s current default target price) or attractiveness (upside) relative to the universe. A Value Score of 100 is the most undervalued and 0 is the most overvalued company in the universe.

All companies listed below met The Applied Finance Group's (AFG's) Buy screen criteria and are in the bottom half of their sector in Market Value/Invested Capital (MV/IC), which by definition qualifies the companies as part of the AFG Value Universe. When identifying buy ideas, AFG looks for companies with the most valuation upside compared to their sector peers, above sector median expected Economic Margin change, and a management quality score that reflects a management team following a wealth creating strategy.

 

9 Value Companies To Watch

A brief description of AFG's buy criteria variables:

AFG's Valuation Metric – Measures the percent to target (deviation between a stock’s current trading price and its AFG current default target price). To derive the intrinsic value of a firm, AFG uses its proprietary Valuation Model (modified discounted cash flow model).

Economic Margin - A corporate performance measurement that addresses the gaps in GAAP, eliminating distortions caused by accounting policies to measure what a company is truly earning above or below their cost of capital.

Management Quality– Assesses management’s ability to make wealth creating decisions.
AFG's Value Universe - Companies in the AFG universe, which have MV/IC at the bottom 50% of the universe and have EPS estimates.

Market Value/Invested Capital (MV/IC) - The firm's average total equity, debt and other obligations divided by net invested capital.

In life, the most attractive people are in shape and have good looks, just look at Hollywood. The same is true the majority of the time in investing. The most attractive stocks have healthy financial statements and look good from a valuation standpoint.

The Altman Z-score is a metric that gives insights into the likelihood of a firm going bankrupt in the next 2 years. The model was developed by Professor Edward I. Altman of the NYU’s Stern School of Business and first published in The Journal of FINANCE in September 1968. A common critique to this metric is that it was developed over 40 years ago and is no longer relevant.

In 2001, Professor Joseph D. Piotroski of The University of Chicago Graduate School of Business, published a paper called, Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers. Piotroski showed that value investors were rewarded by looking at a firm’s financial health and he showed that Z-score was a meaningful statistic.
More recently, on December 5, 2008, Dr. Altman was called to testify before a House of Representatives Committee on the condition of U.S. Automakers. In his testimony, he noted that Bloomberg, Inc. reported, “that approximately 1,000 users of their system per day access the Altman Z-Score model.”

The Altman Z-Score breaks down firms into 3 zones:
• >2.99 – Not Likely to Go Bankrupt
• 1.8 - 2.99 – Gray Area
• <1.8 – Likely to Go Bankrupt in the Next 2 Years

Using AFGView.com, we screened for firms that looked relatively attractive from a valuation perspective and had an Altman Z-Score above 2.99. Below is a list of those firms. Later we will look at firms that are expensive and have a Z-Score below 1.8.

Sales Expectations for Companies with an Attractive Valuation and Healthy Balance Sheet