Pricey Stryker Needs a Deal to Spur Healthy Growth

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NEW YORK (TheStreet) -- Medical device giant Stryker has rewarded investors with year-to-date gains of close to 12%. On its own, that's not a breathtaking number. But when compared to the 7% gain of the medical devices sector, according to Morningstar, it's tough to complain.

It's also tough to argue against how expensive these shares have gotten. Currently, they trade around $83.50.

This now pushes Stryker's price to price-to-earnings ratio past 41. That's 13 points higher than the industry average P/E of 28, according to Yahoo! Finance.

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Investors can have both St. Jude Medical and Medtronic at much cheaper multiples of 25 and 21, respectively. St. Jude and Medtronic both outperform Stryker in gross margin and operating margin.

While the company has done a decent job addressing a wider range of markets within medical technology, the company reconstructive business continues to struggle, growing just 2.5% in the most recent quarter and trailing the likes of Johnson & Johnson , up 3%, and Biomet, which reported 4% in its most recent report before its pending acquisition.

Johnson & Johnson trades at a P/E that is 22 points lower and pays a 2.80% dividend compared to a 1.50% yield for Stryker. Even if we were to use the "investors are paying for growth" argument, Stryker would still be at a deficit to Johnson & Johnson, which is growing a 9% rate compared to 7% for Stryker.

So where's the value?

At a P/E that almost doubles the industry rate, Stryker should -- at least -- post double-digit revenue growth. To that end, it makes sense for Stryker to seek growth through a merger or an outright acquisition. It's one of the ways that companies with tons of cash but short on growth can have instant access new revenue and markets that would have taken years to build.

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Medtronic's $42.9 billion deal for Covidien is one of several recent examples of med-tech M&A that has occurred as companies look to grow and, in some cases, diversify their offerings. Zimmer Holdings wasted no time buying orthopedic device maker Biomet for $13 billion.