Measured Approach

STRYKER CORPORATION (NEW YORK:SYK) Data as of: 12/18/2009

Industry: Medical Equipment & Supplies

Current Data
Current Price $50.50 PEG 0.9
Market Cap ($M) $20,078.8 EPS TTM ($) $2.70
Shares Outstanding (M) 397.6 P/E TTM 18.7X
Institutional Holdings % 60.6% EPS Estimated 2009 ($) $2.94
Insider Holdings % 14.6% P/Estimated EPS 17.2X
Beta 0.97 MA Value ($) $41.25
Latest Quarter Reported 09/30/2009 Dividend Yield % 1.2%

Stryker Corporation is one of the world’s leading medical technology companies with the most broadly
based range of products in orthopedics and a significant presence in other medical specialties. Stryker
works with respected medical professionals to help people lead more active and more satisfying lives. The
Company's products include implants used in joint replacement, trauma, craniomaxillofacial and spinal
surgeries; biologics; surgical, neurologic, ear, nose & throat and interventional pain equipment;
endoscopic, surgical navigation, communications and digital imaging systems; as well as patient handling
and emergency medical equipment.

Jim Edwards, writing in BNET, provides the following history of wrong doing at Stryker.

At Stryker, the maker of bone replacement devices and drugs, there appears to be a
policy of rewarding management for the moral failings of their company. Over the last
two years, Stryker has been the subject of investigations by the SEC, FDA and
Department of Justice into corrupt practices and the manufacturing quality of their

products. You can read the NY Times story on the

most recent criminal convictions here.
The response of the company’s board of directors? To give their top people a pile of
extra stock options and consultancy contracts. What follows is a summary of Stryker’s
legal difficulties and, after that, the rewards Stryker has given its top people in the
aftermath of those difficulties. All the information is drawn from SEC documents:
 Stryker’s legal history:
 2008: One criminal probe into two salesmen who were distributing misbranded devices
and bone drugs and actually giving doctors instructions on how to use them. That’s
right —Stryker salesmen were training bone doctors. The reps pleaded guilty.
 2008: Three warning letters from the FDA regarding quality at three different
manufacturing plants in 2008.

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© Copyright 2009 Ronald Sommer. All Rights Reserved.
  2008: Received subpoena into whether company was complying with a previous
agreement not to pay kickbacks to bone doctors.
 2008: DOJ subpoena received into whether Stryker violated the Foreign Corrupt
Practices act, which bans companies from paying bribes to do business in foreign
countries.
 2007: Settlement of DOJ probe into kickbacks paid to knee doctors.
 2007: SEC inquiry into whether Stryker violated the Foreign Corrupt Practices act, which
bans companies from paying bribes to do business in foreign countries.
 2006: Was the subject of grand jury hearings into whether Stryker was violating
antitrust laws. No charges brought.
That protracted failure of leadership was rewarded with the following largesse in
2008:
 CEO Stephen MacMillan: 150,000 stock options at $42 per share.
 99,000 restricted stock units went to nine members of management, including:
 Curt R. Hartman, Vice President, Finance: 15,000 restricted stock units
 Andrew Fox-Smith, Group President, International: 15,000 restricted stock units.
You’ll notice that at the end of 2008 there was a significant change of management at
Stryker, in which a group president, CFO, and a vp finance all relinquished their posts.
Were they being punished for failing to instill into their underlings a sense of
responsibility? No.
Here’s what they got:
Stephen Si Johnson, Vice President, Group President: relinquished that position but
gets an advisor to the company role: $400,000 in 2009, $200,000 in 2010. Plus benefits.
 Dean Bergy, CFO: relinquished that role but gets an advisory role through 2011,
$450,000 salary. Plus benefits.
None of these executives have been accused of any wrongdoing.

Financial Analysis

An essential step in the valuation of any company is an analysis of its financial performance over time.
Analyzing a company’s financial statements provides an indication of historical growth, liquidity, leverage,
and profitability, all of which influence the value of a company’s equity. The following sections of this
report examine the trend of Stryker Corporation’s balance sheets, income statements, and financial
ratios over the past five years. In addition, the Company’s financial performance is compared to the
median company in the Medical Equipment & Supplies industry as a means of measuring the Company’s
relative historical performance.

Balance Sheets

Presented below are the balance sheets for Stryker Corporation for the twelve month period ending
September 30, 2009 and for the fiscal years ending December 31, 2004 through 2008.

As of September 30, 2009, the Company’s assets totaled $8,459.2 million, up 11% from the end of fiscal
2008. Current assets totaled $5,761.8 million, or 68.1% of total assets, and consisted primarily of short-
term investments (23.3% of total assets), accounts receivable (13.2% of total assets) and inventory (11.6%
of total assets). Since fiscal 2004, inventory decreased as a percent of total assets, from 13.5% to 11.6%
on September 2009. The cash balance of the Company increased by approximately 37% over fiscal 2008,
to $960.3 million from $701.1 million as of December 2008.

As of September 30, 2009, fixed assets including net property, plant and equipment represented 14.7% of
total assets. Due to a lack of new investment, fixed assets declined from 21.6% of total assets in fiscal
2005 to 14.7% of total assets at the end of September 2009.

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Current liabilities were $1,198.0 million as of September 30, 2009, or 14.2% of total assets. Other current
liabilities were the largest current liabilities of the Company on September 30, 2009, accounting for 11.5%
of total liabilities.

Stryker Corporation has no long-term debt.

Due to consistent profitability of the Company over the past five years, shareholders’ equity increased
from $2,752.0 million (67% of total liabilities and equity) at the end of fiscal 2004 to $6,440.9 million (76%
of total liabilities and equity) as of September 30, 2009. This increase in equity indicates the Company’s
financial risk decreased somewhat over the past five years.

Balance Sheet
(Amounts in Millions)
TTM FYE FYE FYE FYE FYE
Assets 09/30/09 12/31/08 12/31/07 12/31/06 12/31/05 12/31/04
Cash 960.3 701.1 290.5 416.6 491.2 349.4
ST Investments 1,969.1 1,494.5 2,120.3 998.2 565.3 0.0
Accounts Receivable 1,113.5 1,129.5 1,030.7 867.2 770.3 751.1
Inventory 977.3 952.7 796.2 677.6 563.5 552.5
Other Current Assets 741.6 701.5 667.2 574.7 479.8 489.6
Total Current Assets 5,761.8 4,979.3 4,904.9 3,534.3 2,870.1 2,142.6
Net Property, Plant & Equip. 1,241.0 1,239.0 1,284.7 1,202.6 1,076.6 700.5
LT Investments 0.0 0.0 0.0 0.0 0.0 0.0
Goodwill/Intangibles 954.9 935.5 925.5 914.8 922.9 963.2
Other LT Assets 501.5 449.5 238.9 222.1 122.9 277.5
Total Assets 8,459.2 7,603.3 7,354.0 5,873.8 4,992.5 4,083.8
Liabilities
Accounts Payable 204.5 274.3 265.5 247.9 206.5 214.5
Short Term Debt 18.1 20.5 16.8 14.8 47.4 9.3
Other Current Liabilities 975.4 1,167.3 1,050.7 1,088.8 994.9 889.7
Total Current Liabilities 1,198.0 1,462.1 1,333.0 1,351.5 1,248.8 1,113.5
LT Debt 0.0 0.0 0.0 0.0 184.2 0.7
Other LT Liabilities 820.3 734.5 642.5 331.3 259.3 217.6
Total Liabilities 2,018.3 2,196.6 1,975.5 1,682.8 1,692.3 1,331.8
Preferred Stock 0.0 0.0 0.0 0.0 0.0 0.0
Common Stock Equity 6,440.9 5,406.7 5,378.5 4,191.0 3,300.2 2,752.0
Total Liabilities & Equity 8,459.2 7,603.3 7,354.0 5,873.8 4,992.5 4,083.8
Book Value Per Share 16.20 13.25 13.13 10.31 8.17 6.86

Income Statements

We present below Stryker Corporation’s income statements for the fiscal years ended December 31, 2004
through December 31, 2009 and for the twelve month period ending September 30, 2009.

As presented, the Company reported increases in revenues in each of the past five years, from $4,017.4
million in 2004 to $6,718.2 million in 2008, for a compound annual growth rate of 14.6%. During the
twelve month period ending September 30, 2009, revenues declined to $6,607.1 million or approximately
2.0%. Stryker’s revenue increases over the five year period were above the 13.2% revenue growth
reported by the medical equipment and supplies industry median.

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Cost of goods sold as a percentage of revenues has fluctuated within a narrow range, from 31.1% to
32.5%, over the past five years. Operating expenses ranged from 77.4% to 83.1% from fiscal 2004 to
September 2009. For September 2009, the Company’s cost of goods sold was 32.5% of revenues.

The Company reported consistent profitability over the past five years. For the period ending September
2009, net income was $1,079.1 million, or 16.3% of revenues. In addition, Stryker’s net profit margin in
September 2009 was improved over the net profit margin of 11.0% in fiscal 2004.

Income Statement
Amounts in Millions
TTM FYE FYE FYE FYE FYE
09/30/09 12/31/08 12/31/07 12/31/06 12/31/05 12/31/04
Sales 6,607.1 6,718.2 6,000.5 5,147.2 4,608.9 4,017.4
Cost of Goods Sold 2,146.5 2,131.4 1,865.2 1,616.6 1,489.2 1,303.8
Gross Income 4,460.6 4,586.8 4,135.2 3,530.6 3,119.7 2,713.6
Depreciation & Amortization 36.3 40.0 41.4 42.7 47.6 44.6
Research/Development 346.5 367.8 375.3 324.6 284.7 214.9
Interest Expense n/a n/a n/a n/a n/a n/a
Unusual Expenses/(Income) 101.9 34.9 19.8 52.7 15.9 120.8
Total Operating Expenses 5,156.4 5,199.2 4,693.2 4,083.6 3,676.8 3,339.5
Operating Income 1,450.7 1,519.0 1,307.3 1,063.6 932.1 677.9
Interest Expense - Non-Op. 0.0 30.5 22.2 6.3 8.1 0.0
Other Expenses/(Income) (30.2) (91.7) (85.0) (36.5) (13.0) 2.9
Pretax Income 1,480.9 1,580.2 1,370.1 1,093.8 937.0 675.0
Income Taxes 401.8 432.4 383.4 322.4 304.5 237.0
Income After Taxes 1,079.1 1,147.8 986.7 771.4 632.5 438.0
Adjustments to Income 0.0 0.0 0.0 0.0 0.0 0.0
Income for Primary EPS 1,079.1 1,147.8 986.7 771.4 632.5 438.0
Nonrecurring Items 0.0 0.0 30.7 6.3 11.1 2.0
Net Income 1,079.1 1,147.8 1,017.4 777.7 643.6 440.0
EPS Basic 2.72 2.81 2.48 1.91 1.59 1.10
EPS Diluted 2.70 2.78 2.44 1.89 1.57 1.08

Ratios

We present various financial and operating ratios for Stryker Corporation for the last five years.

Liquidity ratios indicate the ability of the company to meet current obligations as they come due. The
liquidity ratios presented below indicate the Company’s liquidity has improved over the past five years.
The current ratio increased from 1.9 at the end of 2004 to 4.8 on September 30, 2009. Similarly, the quick
ratio increased from 1.4 to 4.0, and the Company’s working capital increased to $53.9 million from 25.2
million over the same time frame.

Activity ratios indicate how effectively a company is utilizing its assets. Receivables turnover, inventory
turnover and asset turnover ratios all indicate stability in the Company’s ability to manage its assets.

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 COMPARATIVE RATIOS
TTM FYE FYE FYE FYE FYE
Profitability 09/30/09 12/31/08 12/31/07 12/31/06 12/31/05 12/31/04
Gross Profit Margin % 67.50 68.30 68.90 68.60 67.70 67.50
Industry Median 50.00 51.60 52.90 51.50 50.30 50.00

Operating Margin % 22.00 22.60 21.80 20.70 20.20 16.90

Industry Median (14.60) (12.00) (6.20) (5.90) (4.40) 0.10

Net Profit Margin % 16.30 17.10 17.00 15.10 14.00 11.00

Industry Median (10.00) (9.00) (8.10) (4.30) (3.80) 0.00

Return on Equity % 18.30 21.30 21.30 20.80 21.30 17.90

Industry Median 6.60 2.70 4.20 3.70 5.20 7.70

Return on Assets % 13.70 15.30 15.40 14.30 14.20 12.10

Industry Median (25.90) (23.50) (19.80) (15.60) (16.40) (5.40)

Liquidity
Quick Ratio (X) 4.00 2.80 3.10 2.10 1.80 1.40
Industry Median 1.60 1.60 1.80 1.80 1.70 2.10

Current Ratio (X) 4.80 3.40 3.70 2.60 2.30 1.90

Industry Median 2.30 2.30 2.60 2.50 2.30 2.70

Payout Ratio (X) 14.70 14.20 13.30 11.50 6.90 8.20

Industry Median 0.00 0.00 0.00 0.00 0.00 0.00

Times Interest Earned (X) n/a 52.80 62.70 174.60 116.70 n/a
Industry Median (2.00) (1.70) (1.20) (1.60) (1.00) 1.20

Debt Management
Total Liabilities to Total Assets % 23.90 28.90 26.90 28.60 33.90 32.90
Industry Median 46.60 43.50 38.00 35.40 37.80 32.60

Long-Term Debt to Capital % 0.00 0.00 0.00 0.00 5.30 0.00

Industry Median 1.70 1.70 1.40 0.70 1.30 1.60

Long-Term Debt to Equity % 0.00 0.00 0.00 0.00 5.60 0.00

Industry Median 1.00 0.50 0.80 0.10 0.40 1.20

Asset Management
Receivables Turnover (X) 6.00 6.20 6.30 6.30 6.10 6.40
Industry Median 6.30 6.30 6.40 6.10 6.10 5.90

Inventory Turnover (X) 2.20 2.40 2.50 2.60 2.70 2.60

Industry Median 2.60 2.70 2.80 3.00 3.00 3.10

Asset Turnover (X) 0.80 0.90 0.90 0.90 1.00 1.10

Industry Median 0.80 0.80 0.70 0.70 0.70 0.80

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Coverage ratios indicate the ability of the company to meet interest payments, and leverage ratios
indicate how much debt the company has outstanding. Highly leveraged companies and companies with
low coverage ratios are more vulnerable to business downturns. Since Stryker does not have long-term
debt, coverage ratios are not applicable.

Profitability ratios reflect the returns earned by the Company and assist in evaluating management
performance. Stryker Corporation has been consistently profitable in each of the past five years and in
the twelve month period ending September 2009. The Company’s return on sales improved from 11.0% in
2004 to 16.3% in September 2009, while return on assets improved to 13.7% in September 2009 from
12.1% in fiscal 2004. In addition, return on equity increased to 18.3% from 17.9% during the same period.

VALUATION CONCLUSIONS

We place a target price of $41.25 on the common shares of Stryker Corporation. We recognize this
implies a discount to current and historic multiples to forecasted earnings and sales. However, we feel
this target is justified. Though future earnings are the chief determinant of value, we also take into
consideration a number of other factors. These factors are considered in determining a capitalization rate.

We consider the long-term prospects of a company. We do not know what the future will be but there are
disconnects between the value of individual companies and an industry. In the case of Stryker, we believe
the Company’s ability to sustain margins superior to the industry is questionable when considering the
Company’s legal problems and uncertainty surrounding healthcare reform.

The role of management is one of those qualitative factors that are difficult to measure. However, if past
is prologue, then a company’s past performance provides some indication of what we can expect in the
future. Stryker has consistently reported growing profits and free cash flow.

There is something to be said for a company that is financially strong and has a sound capital structure.
Stock of a company with surplus cash and nothing ahead of the common is clearly a better purchase than
another one with the same per share earnings but large bank loans and senior securities.

One measure of quality is a company’s ability to provide a safe dividend. Stryker pays a dividend well
covered by earnings as the payout ratio is a low 14.7 percent. The current dividend yield is about 1.2
percent.

Disclosure: The author has no position in SYK.

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© Copyright 2009 Ronald Sommer. All Rights Reserved.