Economic concerns ranging from elevated inflation to interest rate hikes have heavily weighed on financial markets this year. This explains why the S&P 500 index has dropped over 17% so far in 2022.
But many stocks have outperformed the index during this time, especially in healthcare. Down just 11% to this point in the year, Stryker (SYK 0.97%) fits into this category. This raises the following two questions: Can the stock's market-beating performance continue? And is Stryker a buy?
Let's dive into the company's fundamentals and valuation to get answers to these questions.
A top line that's moving higher
In the 81 years since it was founded, the Kalamazoo, Michigan–based medical devices company has become one of the largest businesses in its industry. Stryker's $89 billion market capitalization positions it as the third-largest medical devices company in the world.
Stryker reported $4.5 billion in net sales during the third quarter (ended Sept. 30), a 7.7% growth rate over the year-ago period. What led to the healthy net sales growth for the quarter?
The medical devices company has launched numerous products since the year-ago period. In September it launched the Gamma4 System for the treatment of stable and unstable fractures. Back in May it launched the EasyFuse Dynamic Compression System, used by foot and ankle surgeons to simplify surgeries and reduce waste in the operating room.
As a result of Stryker's innovative culture, the company's constant currency net sales surged 11.4% higher in the third quarter. Given that Stryker is a global company that converts foreign currencies into U.S. dollars for reporting purposes, it faced a 3.7% unfavorable foreign currency translation headwind during the quarter. That's because the U.S. dollar was much stronger for the quarter than in the year-ago period.
Stryker's non-GAAP (adjusted) diluted earnings per share (EPS) decreased 3.6% year over year to $2.12 in the third quarter. Due to faster growth in the company's cost of sales (11.8%) than in net sales, Stryker's non-GAAP net margin fell nearly 220 basis points over the year-ago period to 18.1%. This reduced profitability was partially neutralized by a 0.2% decline in the company's weighted average share count to 381.8 million during the quarter. That explains how Stryker's adjusted diluted EPS growth was materially lower than its net sales growth for the quarter.
As inflation tapers off and supply chain problems begin to fade, the company's profitability should recover. This, along with new product launches and acquisitions, is why analysts are predicting that Stryker's adjusted diluted EPS will compound at 7.5% annually over the next five years.
Image source: Getty Images.
Dividend growth could make up for lower yield
Compared to the S&P 500 index's 1.6% dividend yield, Stryker's 1.2% yield may seem lacking. But for investors with time to let the company's dividend compound, this starting income is deceptively low.
That's because Stryker's dividend payout ratio is poised to come in at just about 30% in 2022. This leaves the vast majority of the company's earnings available to be redeployed into future growth opportunities and to repay debt. That's why I believe the dividend will grow at a faster rate than earnings, which should translate into double-digit annual dividend growth for the medium term.
The valuation is fair
Stryker's fundamentals are solid. And the stock doesn't appear to be fully valued at the current share price. Stryker's forward price-to-earnings ratio of 24.6 is just below the medical devices industry's average multiple of 24.8.
All of this makes the stock a buy for dividend growth investors looking to top the S&P 500 index in the future.
