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Dear Mr. Berko:

Dear R.E.:

That broker’s got a case of “ignis fatuus” 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 backbones, 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 Corp. (SYK-$40.66) is a $6.7 billion revenue company that designs, produces and sells orthopedic implants, hips, knees, spinal and craniomaxillofacial, or facial and skull, implants that generate 60 percent of its revenues. SYK also makes the tools that attachs 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. SYK 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 kerfuffle might have disjointed that remarkable record, and patients are delaying expensive elective surgeries. Growing unemployment could continue to dampen SYK’s revenues. Meanwhile, analysts believe hospital spending, which has declined about 20 percent this year, will pick up 4 percent to 7 percent in 2010. The Street also believes that implant procedures will begin to increase in the last quarter of 2009 and improve dramatically in 2010. If the Street observers are right, SYK could move to the low $50s. But if they’re wrong — I believe they are — then SYK could trade in the $33 to $35 range.

SYK 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 SYK survive President Barack Obama’s health-care reform, which 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’t see that happening for a while. Do not buy the stock, which is down from its 52-week high price of $69.

Johnson & Johnson (JNJ-$60.27) has traded in a narrow 10- 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 shareholders’ equity remained steady at 28 percent. This suggests that JNJ shares might have been too highly priced for the past half-dozen years.

This is the world’s largest health-care-product company, with $63.4 billion in 2008 revenues, and this year could be the first in JNJ’s 100-plus-year history that revenues (even with 106 subsidiaries) will decline. JNJ’s prescription drug sales are losing ground (especially Risperdal and Topamax) to generics, and anemia drug Procrit appears to have some safety issues. JNJ’s drug-coated stent is losing sales to rivals, smaller hospital budgets are crimping institutional revenues and tighter consumer thrift has dampened retail sales. What’s more, private-label brands have lowered over-the-counter revenues, including JNJ’s highly profitable and impressive wound card product sales.

I see no reason for JNJ to trade in the high $70s in the coming year. And though JNJ has enjoyed an average price-to-earnings ratio of about 19 during the last decade, I think a P/E of 12 to 13 is now more likely. So, with expected earnings of $4.55 per share this year, the stock seems fairly priced at $54-$57, and I’d not be a buyer.

Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, Fla. 33775 or e-mail him at mjberko@gmail.com. © 2009 Creators.Com