Medical Value, Medical Growth

04/14/2006 12:00 am EST


Marc Gerstein

Editor, Forbes Low-Priced Stock Report

Marc Gerstein offers two excellent servicesone focused on growth, the other on value. He specializes in "screening" to select stocks for each. Here’s a look at his latest buys in each his services, both of which happen to be in the medical sector.

"Risk premiums in global financial markets are extremely low, meaning that investors are not only optimistic, they’ve been downright complacent, almost convinced that nothing negative could possibly happen. That’s an excessive view that looks like it may now be starting to correct. If that’s so, this alone would push up interest rates (which include a risk-premium component).

"Meanwhile, the US is not a closed economic system wherein the only important things are those that happen here. Talk of our twin deficits (both the budget and trade deficits) is old hat. The reason why neither of these have damaged the economy or the dollar is the incredible willingness of foreigners to continue to reinvest their currency reserves in the United States.

"In other words, the excess dollars they earn by selling to consumers here aren’t translated back to their local currencies (something that would, if it occurred, badly pressure the dollar). Instead, foreign reserves are heavily invested in US Treasuries. But with interest rates starting to rise in other countries and economies elsewhere starting to show more need for capital, and with a generally increased desire for diversification, especially in China, our biggest creditor, the US may have to work harder to compete for capital.

"I think we’ll succeed. We have a great economy and financial system, and ought to be more than able to hold our own in a fair competition. But to do that, we may have to ante up a bit more in terms of how much we reward investors for staying here. Translation: higher interest rates. I don’t see rates going so high as to damage our economy. But I do see them going high enough to give an emotional jolt to our complacent investment community.

"Because neither our Reuters Growth Review and Reuters Value Review newsletters are market-timing services, I’m not inclined to dump model portfolio names in order to play a correction. But I am inclined to be more thoughtful about what positions join or stay in the portfolios. Only one new name is joining our portfolio at this time, micro-cap Medical Action Industries (MDCI NASDAQ).

"The company makes disposable medical products, which are marketed to acute care facilities. The product line is varied, but an over-arching theme is disposable surgical offerings. Its products are sold through all the big-time medical products distributors such as Cardinal Health, Owens & Minor, McKesson, and tends to have preferred vendor status and the sole source of certain products.

"The company has acquired frequently and successfully in the past (the balance sheet and returns on capital are strong) and will likely continue to make acquisitions in the future. The ‘downside,’ so to speak, here is size. At a bit below $250 million, MDCI is small even in the micro-cap universe. That tends to add short-term volatility to the stock. However, in order to justify the current stock price, five year earnings per share growth would need to be only 7.5%.

"In our growth portfolio, we are adding Endo Pharmaceuticals (ENDP NASDAQ). This is a an example of small pharma, a pharmaceuticals company that specializes, as opposed to being all over the map. Its s specialty is pain relief, an area always of keen interests to sufferers (obviously) and of increasing interest to the health care community mainly its ability to respond is improving.

"Presently, ENDP’s main product is Lidoderm, a patch mainly used to treat shingles but which is increasingly finding new ‘off-label’ uses, such as for carpal tunnel, low back pain, and so forth. The big catalyst is Oxymorphone ER, a true twice-per-day relatively low dose (others that make the claim really require three doses) formulation. FCC approval is expected in mid-year. Rivals are generic now and, hence, not being vigorously promoted.

"There is legal risk involving a patent dispute in ENDP’s generic Oxycontin, but the judicial momentum seems to favor ENDP. I can tolerate such uncertainty because ENDP’s business and balance sheet can handle even a worst-case scenario. Note, too, that the stock is attractively valued. A five-year average earnings per share growth rate of 9.3% is needed to justify the current stock price, while I believe the probable rate of earnings per share growth is 18.2%."

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