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Henry W. Schacht
Henry W. Schacht

A Lesson from Boston Scientific

Anyone who doesn't own Boston Scientific (NYSE:BSX) is once again breathing a sigh of relief. It seems like an ever shrinking list. Holders of BSX include Paulson & Co., Primecap, Dodge & Cox, Wellington, Greenlight Capital (Einhorn), and even Brandes. It's a Who's Who in Investment Royalty.

We mere mortals in the field have taken notice. And the logic seems clear enough. First there is the attractive demographics. We're all falling apart and will need everyone from Medtronic (NYSE:MDT), Johnson & Johnson (NYSE:JNJ), and Abbott (NYSE:ABT) to Stryker (NYSE:SYK), Zimmer (ZMH), and St Jude (NYSE:STJ) to duct tape us back to relative health.

Then there is the valuation: Of the group, Boston Scientific seems to be the weak sister, trading at a depressed multiple to cash flow. After disastrously overpaying for Guidant (2006), much of this appears warranted. That said, management seems to have done a good job paying down debt. In fact, most (if not all) of free cash flow has been devoted to this purpose.

A quick glance at Value Line shows the expectation of $1 a share (or $1.5 billion) in free cash flow this year. At the current price of $6.58 a share (or a $9.9 billion market cap), that's a rather healthy return on one's investment. Or so the theory goes. Unfortunately for Boston Scientific investors, both numbers are dropping fast.

We've gotten numerous calls and emails lately about the venerable firms lining up at BSX's doors. Riding shotgun has been costly. You'd have been far better off following Bruce Berkowitz and his Fairholme Fund into Citigroup (NYSE:C) or even Regions Financial (NYSE:RF).

As the market has risen, the number of quality ideas has fallen. So value investors are rapidly sliding down the quality scale in the hunt for worthwhile purchases. I know, it's all about price. But some companies have the ability to screw up a free lunch.

Boston Scientific (NYSE:BSX) may be one such firm. And yet I still find myself looking at it from time to time. It may well prove to be an excellent investment at this price, but it's a tough sell. The defection of sales personnel is a major concern and overall competition is still fierce.

Does BSX do anything that others don't do (better)?

Maybe John Paulson and David Einhorn know. I don't.

The real lesson (courtesy of BSX):

Regardless of how rich and/or famous an investor is, don't blindly follow them into any investment. If a company makes you uneasy, avoid it. Put your own personal warning label on it and look elsewhere. Opportunities will arise. Just do your own work and think for yourself.

Disclosure: No positions.

Henry W. Schacht


About the author:

Henry W. Schacht
Henry W. Schacht, CFA is the founder of Schacht Value Investors, an investment management firm serving individuals and institutions. He currently serves as President and Chief Investment Officer. He earned his MBA at the University Of Chicago Graduate School of Business and a BBA in finance from the University of Notre Dame. Mr. Schacht is a member of the Association for Investment Management & Research (AIMR), the Investment Analysts Society of Chicago (IASC), and the National Association of Corporate Directors (NACD).

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