Stryker's Still Too Risky

NEW YORK ( TheStreet) -- There's not much anyone can do whenever the Street has made up its mind about fundamental metrics on which it wants focus. Nor can we control what the Street decides to completely ignore. But I can't see how shares of Stryker ( SYK) makes any sense at these levels.

The last time we discussed this company, I told you that the stock was too expensive. Not only was Stryker (at the time) trading at a P/E of 21, which (then) exceeded the industry average of 20, but the stock was also trading at a P/E three points and four points higher than rivals Zimmer Holding ( ZMH) and Covidien ( COV), respectively.

If that was not enough, add the fact that the company was mired in legal battles due to product recalls for two of its artificial hip implants. Even then, the stock was up 20%.

Now, following another subpar quarter, I'm even more concerned about the growth challenges that lie ahead, even if the Street believes the company will get by unscathed.

It's pointless to dispute Stryker's strong market position. I won't disagree that the company has a solid lead in the in the orthopedic and medical technology market where it competes with (among others) Johnson & Johnson ( JNJ) and Medtronic ( MDT). But that's not the issue here.

What concerns me is, as seen by the stock's recent 52-week high and 11% gain over the past three months, investors are already pricing in a victory over the recall situation. Whether or not this works in your favor, it doesn't excuse the fact that this is a dumb bet and completely unnecessary. Bulls will disagree.

However, before you send your emails, consider that in the most recent quarter the company earned 56 cents per share on revenue of $2.21 billion. The earnings-per-share amounted to $213 million, which means that earnings declined by 35% since the April quarter. For a stock that is trading at such enormous expectations, while carrying above-average risk, I don't believe that investors should be please with 4% organic growth.

As with the April quarter, I wasn't all that impressed with Stryker's segmental performance. While the company did well in orthopedics, growing by more than 7%, the company's MedSurg segment grew just 4% (as reported). Even its Stryker's hip and knee business, which both grew in mid-single-digits, the company didn't meaningfully outperform Johnson & Johnson, which carries significantly less investment risk.

In that regard, unlike the April quarter, it was clear the product recalls have begun to take a toll. That the company posted only a 1% growth in instruments serves as perfect example. Management was able to offset the weakness with a better-than-expected showing in its Neurotechnology and Spine business, which was up 10% year over year.

I'm willing to credit management for this performance. This is an area where Stryker competes directly with Covidien, and it certainly looks as if Stryker is winning market share in this segment. But that was the extent of any good news that I could find in this report. Typically, when a company underperforms on revenue there is usually a "silver lining" or two that manifest itself on the operating side, particularly in margins. But this was nowhere to be found.

Stryker posted a 50-basis-point decline in gross margin and missed estimates on operating income. It certainly didn't help that the company increased spending on research and development. To be fair, I'm not ready to say that an increase in R&D is inherently bad. I don't believe that companies can compete absent meaningful R&D investments, especially in the medical technology industry. But an important role of management is to produce operating leverage, and I don't believe that Stryker has demonstrated this enough.

To that end, management also reduced the company's full-year earnings outlook. Stryker now expects full-year revenue growth to be in the range of 4% to 5.5%. Earnings, meanwhile, are expected to be between $4.20 and $4.26, down from its prior guidance of $4.25 to $4.40.

It still remains to be seen how the recall situation unfolds. But it doesn't inspire confidence that management is revising lower while a decision hangs in the balance. Accordingly, with the stock still posting new highs, I would listen to Warren Buffett and be fearful right here.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.
Richard Saintvilus is a co-founder of StockSaints.com where he serves as CEO and editor-in-chief. After 20 years in the IT industry, including 5 years as a high school computer teacher, Saintvilus decided his second act would be as a stock analyst - bringing logic from an investor's point of view. His goal is to remove the complicated aspect of investing and present it to readers in a way that makes sense.

His background in engineering has provided him with strong analytical skills. That, along with 15 years of trading and investing, has given him the tools needed to assess equities and appraise value. Richard is a Warren Buffett disciple who bases investment decisions on the quality of a company's management, growth aspects, return on equity, and price-to-earnings ratio.

His work has been featured on CNBC, Yahoo! Finance, MSN Money, Forbes, Motley Fool and numerous other outlets.