By Matt Doiron
We track quarterly 13F filings from hundreds of hedge funds and other notable investors. Even though the information in 13Fs is a bit old by the time these filings are released, there are still a few ways to make use of it. For one, we have found that the most popular small-cap stocks among hedge funds earn an average excess return of 18 percentage points per year (learn more about imitating hedge funds' small cap picks) and think that more strategies are possible as well. We also like to look through top managers' filings for major changes. In the first quarter of 2013, both Stephen Mandel's Lone Pine Capital and Andreas Halvorsen's Viking Global more than doubled the size of their positions in Intuitive Surgical (ISRG). Both of these managers are "Tiger Cubs" having previously worked under legendary investor Julian Robertson at Tiger Management, and both have become billionaires themselves (see a history of Lone Pine's or Viking Global's stock picks).
Intuitive Surgical's stock price is about flat year to date, after rising strongly in late January but then plummeting in price between late February and mid March. The stock price fell over 10% on news of an FDA inquiry into its daVinci robotic surgery system (the company's primary product) and how well doctors are trained on it; short selling research company Citron Research has also been calling Intuitive Surgical overvalued for some time and questioning the cost-effectiveness of the da Vinci.
In any case, results were strong last quarter as Intuitive Surgical reported a 23% increase in revenue compared to the first quarter of 2012. Net margins actually increased - which, if anything, would indicate to us that customers are not demanding reductions in the company's pricing - with the result being a more than 30% increase in earnings. The company also tracks volume of different medical procedures using its system, providing another window into demand. Over half of cases in 2012 were related to gynecological surgery, and over the past couple years this use has grown slightly faster than that of overall procedures. General surgery uses have been growing rapidly as well though they remain a small share of cases. Markets have already priced high earnings growth into the stock, however, with trailing and forward P/Es of 30 and 24 respectively.
Two smaller-cap surgical device systems companies- though average daily dollar volume is over $1 million in each case - are MAKO Surgical (MAKO) and Accuray (ARAY). Each of these companies is unprofitable on a trailing basis, and while their bottom lines are expected to improve on a forward basis each remains in the red- MAKO with a projected loss of 25 cents per share and Accuray at 40 cents. Each of these stocks is down in the last year, MAKO by over 50%, in what has been a rising market. While that company did experience a 26% revenue growth rate in the first quarter of 2013 versus a year earlier, Accuray is in quite worrisome straits: sales are down, and the most recent data shows that 24% of the float is held short.
We can also compare Intuitive Surgical to medical device companies Medtronic and Boston Scientific. Boston Scientific has also been somewhat troubled, with sales down 6% in its most recent quarter compared to the same period in the previous year. However, markets are expecting strong improvement at the company: a nearly 60% rise in the stock price over the last year has placed the stock at 19 times forward earnings estimates. Medtronic's business has been fairly stable, with limited changes on both top and bottom lines. The stock is still out of pure value territory with a trailing P/E of 15, though even with lower growth this is a very large discount to Intuitive Surgical.
Medtronic is easily the cheapest of these stocks in terms of trailing earnings, and going by recent conditions we'd prefer to avoid the other three peers we've discussed here. As for Intuitive Surgical, we're impressed by its recent numbers though would think that another quarter or two of financials might provide more insight as to whether the company can grow enough to justify its current valuation let alone make it worth buying.