Medtronic: Finding the Bottom

The market cannot keep punishing this medical-device powerhouse, whose share price is down 21% in 2006.

Medtronic embodies everyone's frustration with the poor performance of so-called megacap stocks. Good earnings, a high return on equity, innovative new products, lots and lots of cash on the balance sheet -- you name it, Medtronic is a sound company. But merely being sound doesn't cut it in a market that remains hostile to the likes of big growth companies such as Microsoft, Wal-Mart and, yes, Medtronic.

Medtronic, by far the largest manufacturer of medical and orthopedic devices by stock-market value, has been a major disappointment to investors. At $45, the stock (symbol MDT) has essentially done nothing over the past five years, although the company's profits grew by 150% over that period.

This week's earnings report, for the quarter that ended July 28, contains enough hopeful news that Medtronic shares look like a good bet to make up for some of this lost time. For one thing, Medtronic backtracked from its tradition of publicly forecasting 15% sales and earnings growth for the next several years. That gives it some wiggle room if it takes longer than advertised to realize substantial returns on its research into new products for back and spine trouble, diabetes, and neurological disorders -- the areas that can compensate for slowing growth in cardiac devices.

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It may sound silly, but if a company predicts 15% growth and makes 13%, investors may punish the stock. Don't promise such growth, and it becomes easier to make the number or to find a way to surprise the market to the upside. Analysts and investors actually sometimes go for this stuff. "A much-needed cut" in guidance, says Cowen Co. Prudential Securities suggests that Medtronic officials really do aim to achieve 15% growth but are promoting the smaller number to analysts and investors.

Medtronic's stock could have suffered some more on August 23, but its quarterly earnings of 55 cents a share beat the average analyst estimate of 54 cents. So the stock barely budged. Three weeks ago, however, when the company warned that its defibrillator business had some problems, the stock plunged from $51 to $44. At $45, it's priced at 19 times profit estimates for the fiscal year ending next April -- about half the price-earnings ratio this stock commanded during its glory days of the 1990s. That's a reasonable price, especially when you factor in all the demographic appeal of a company that profits when baby boomers need expensive surgery and cardiac care.

Skeptics counter that, like Wal-Mart, Medtronic's best days are behind it. But if the megacaps ever get a little more respect, Medtronic deserves to be released from five years in investor purgatory.

Jeffrey R. Kosnett
Senior Editor, Kiplinger's Personal Finance
Kosnett is the editor of Kiplinger's Investing for Income and writes the "Cash in Hand" column for Kiplinger's Personal Finance. He is an income-investing expert who covers bonds, real estate investment trusts, oil and gas income deals, dividend stocks and anything else that pays interest and dividends. He joined Kiplinger in 1981 after six years in newspapers, including the Baltimore Sun. He is a 1976 journalism graduate from the Medill School at Northwestern University and completed an executive program at the Carnegie-Mellon University business school in 1978.