A Tale of Two Sales – Part I

Posted March 3rd, 2011. Filed under Investing Philosophy

Selling positions is often harder than buying. It is all too easy to get married to certain positions and hold on for too long.

To improve my performance in this area, I’ve tried to avoid eking out the last few percentage points as an investment rises closer to my valuation range.

Undoubtedly, I had some flaws in my original analysis (investing is not an exact science), which means my range probably wasn’t perfect in the first place – sometimes it’s best to just move on to a new position.

This is Part 1 of the thought process behind two of my most recent sales.

Stryker Corp (SYK)

My blog currently focuses on microcaps so this giant ($25b market cap) medical company is a bit outside of the blog’s normal scope.

However, the recent financial crisis brought about an amazing opportunity to pick up wonderful businesses at historically low prices. SYK was one of those picks.

The company competes in the ultra-competitive medical device segment with companies like Zimmer and J&J. – think hip replacements, knee replacements, and other medical supplies.

The company is an amazingly stable performer, with sales rising from $5.4B in 2006 to $7.3B in 2010 without a single down year.

EBIT has improved on a similar uptrend, as operating margins increased up to the current 24%.

FCF has followed, growing from $892m in 2006 to $1.5B in 2010, for a current FCF yield of 6.01%

5 year ROE (18.59%), ROIC (17.65%), and CROIC (21.06%) are all outstanding, especially for a company sitting on $3.3B in net cash.

So Why the Sale?

When I purchased SYK in the summer of 2009, the stock was selling for under $40/shr, for an EV of approx $14B.

This translated into an EV/EBIT of 9x and EV/FCF of 10x – very low for a company that showed no signs of slowing down its growth in sales, profits, or cash flow.

The stock is up over 60% since that time and currently trades at an EV/EBIT of ~12.5x and EV/FCF of 14.4x (or 14.4x and 16.5x using 5-year average EBIT & FCF figures respectively).

My conservative DCF valuation provides a valuation range of $65-$70 per share.

While there is still a good chance that the stock is undervalued, the margin of safety has shrunk considerably.

Short-term, the new health care legislation will affect the profitability of medical devices makers, with a 2.3% excise tax due in the next 2-3 years.


Long-term, I think the stock will outperform (the baby boomers are a driving force: older baby boomers = higher demand for joint replacements!) but believe there are better, and significantly more undervalued areas, to place my money.

So I sold.

When I started out investing, I tried to keep a significant portion of my portfolio in these large stable names with a strong competitive moat (many would describe this as the new Buffett philosophy).

Today, I’m more comfortable hustling to find the microcap stocks that are significantly undervalued (the old Buffett philosophy).

Since I’m willing to put in the work, I sometimes make the decision to sell a great stock for the chance to earn even greater returns in another investment idea.

At least for now, I’m sticking with the old.

Part II – Stay tuned!


No positions

P.S. –  Rational Walk has a great summary of closing his position in Noble Energy (NE). I went through a very similar experience with NE – check out his summary for a great write-up.

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