(Editor’s Note: This article covers a stock trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.)
Three months into 2014 we have seen a slight pullback and another leg higher in equities, so far. Economic reports initially showed some weakness from the fourth quarter of 2013, as seen with a weak housing figures, manufacturing, and revised GDP lower. Additionally, Russia's military deployment to Ukraine has also caused investors to question risky assets and the current valuation of the market. Despite these facts, the S&P 500 still managed to log in a new high recently and continues its bull run. The bullish run higher has caused volatility to pullback from its year to date high of 21.44 to its current 14.16. However, I do expect a bump in volatility over the next several months.
Source: Google Finance
While we are certainly in an aged bull market, it is time for investors to begin the gradual switch to more stable, high quality stocks. One such industry that is seeing long term growth is the medical device field. According to a report done by ResearchandMarkets, the market for medical devices will grow to $65.6 billion by next year. Additionally, the report highlighted that North America currently accounts for 40% of medical devices, followed by Europe at 30% and Asia at 11.6%. With an overwhelming demand for upgraded health care equipment in populated Asian countries such as China and Japan, we could see a majority of industry's growth coming from these regions.
With demand for more precise and upgraded health care equipment rising, I believe these four companies with exposure to the medical device field could benefit: Johnson & Johnson (NYSE:JNJ), Intuitive Surgical, Inc. (NASDAQ:ISRG), Stryker Corporation (NYSE:SYK), and Sanomedics International Holdings, Inc. (OTCMKTS: OTCPK:SIMH).
Johnson & Johnson
Johnson and Johnson , according to Trefis, has medical devices as the top contributor to its stock price, at about 61.5% or over $20 billion in revenues. While J&J has a diverse array of products to hedge against any fall in demand, the company's devices focus on cardiovascular diseases, delivery, neurological, etc.
Turning to the fundamentals, Johnson & Johnson has a market cap of $263.22 billion and is currently rated a "weak buy" from analysts. Overall, the stock's valuation ratios are overvalued when looking at a price to sales of 3.69, price to book of 3.55, price to cash of 9, and price to free cash flow of 40. Earnings estimates come in at 24.6% gain this year, 7.7% next year, and 5.92% over the next five years. Margins are quite good: gross margin of 69%, operating margin of 26%, and profit margin of 19%. The company pays a annual dividend of 2.83%.
Overall, Johnson & Johnson is the best bet for investors looking for a large cap, diversified healthcare company that has a good amount of exposure to the medical device field. Shares are not cheap by any means, but growth appears stable and certainly is the more conservative option compared to the other stocks in this article.
Intuitive Surgical, Inc. is a developer of what is known as a "surgeon's console". Their da Vinci medical device brand assists surgeons during surgery and the company markets the device as a more precise device made to help limit mistakes. According to Trefis, the da Vinci system accounts for 19.6% of the stock price, behind instruments at 43.5% and services at 21.1% of the stock price.
Much like J&J, Intuitive Surgical is no bargain. The company has a market cap of $17.08 billion and is rated a "weak buy" from analysts. Valuation ratios represent an overvalued state currently as seen with a price to sales of 7.54, price to book of 4.88, price to cash of 12.17, and price to free cash flow of 22. However, ISRG has no debt to speak of and 36.93 in cash per share. Earnings growth is expected to stumble this year at 4.7%, 13.44% next year, and 9.55% over the next five years. Margins are outstanding: gross margin of 70%, operating margin of 38%, and profit margin of almost 30%.
Overall, Intuitive Surgical has a much higher exposure to its medical devices in terms of earnings than J&J. However, the company has no debt, awesome margins, and better earnings growth rates over the next several years. With a beta of 1.27, this stock can certainly be volatile during periods and extra hedging may be required for long term investors to avoid losses during downturns.
Stryker Corporation is a medical device company with the largest exposure the field in terms of earnings, making it the most aggressive play out of the three companies. Stryker operates in three separate segments to which it provides medical devices for: Reconstructive, MedSurg, and Neurotechnology and Spine. The Reconstructive segment uses implants for parts such as knees and hips and provides trauma devices. MedSurg is the unit that provides the surgeon assistance devices that help provide precision during surgeries and Neurotech/Spine unit provides devices for highly invasive surgeries such as brain and spine.
Stryker is a $30.98 billion company that has the strongest "buy" rating of the group. However, like the other two companies, Stryker has overvalued valuation ratios: price to sales of 3.43, price to book of 3.42, price to cash of 7.78 and price to free cash flow of 24. Earnings growth is expected to decline -22% this year, rise 9.09% next year and 8.85% over the next five years. Margins are decent with a gross margin of 67%, operating margin of 15.6%, and profit margin of 11.2%. The company pays an annual dividend of 1.49%.
Overall, Stryker may be a larger company that Intuitive Surgical, but Intuitive offers other services and equipment other than medical devices. Stryker relies on the sales of their medical devices much more, as seen through this year's earnings per share estimates: 4.7% for ISRG and -22% for SYK. Additionally, I do think Intuitive has slightly better fundamentals as well. That being said, Stryker does pay a dividend and has had a stronger performance compared to Intuitive over the last year.
Sanomedics International Holdings
Sanomedics is a medical technology holding company that essentially buys businesses that produce "game changing products, services and ideas". Management highlights that they use organic growth and acquisitions to help make the business grow. Last year, Sanomedics acquired a home medical equipment company called Prime Time Medical. The great thing about the deal was that Sanomedics paid $3 million for a company that was generating $5 million annually. Additionally, the company secured a $5 million line of credit from TCA Global Fund LLC to fund future acquisitions back in January 2014.
According to Wall St Cheat Sheet, the typical acquisition target were healthcare based, local brands that could generate national and international returns, contained "immediate impact" for clients in the form of lower costs, or other benefit, and is profitable. Wall St Cheat Sheet's Matt Levy continued to say "As Sanomedics continues to execute its long-term growth plan, the potential is there for the company to eventually generate revenues north of $100 million per year".
The bottom line here is that Sanomedics is the most aggressive way to play the medical device growth. The company certainly has a mentor to follow in Integra LifeSciences Holdings Corporation (NASDAQ:IART), which operates under a very similar business model. To be certain, if the analysts are right and Sanomedics is able to continue purchasing profitable companies at a discount, we could see a jump in price action. However, this is certainly the riskiest way to play the space and would be recommended to high risk, high reward investors.
With big growth estimates projected from the medical device industry, there are a lot of ways to play it. I have offered you a conservative, moderate, moderate-risky, and risky stock that would benefit the rise in demand in medical equipment. Safety minded investors with a conservative style should look at Johnson & Johnson, moderate risk investors should look at Intuitive Surgical and Stryker, and high risk, high reward investors should investigate Sanomedics. No matter which risk tolerance you choose, all will benefit from the continued demand for better medical equipment.
Obviously, these larger cap names are going to have some overvalued metrics as we highlighted above. However, in an aged bull market, there is not a whole lot of sales going on and certainly hard to pick up high growth names such as these for a steep discount. As growth continues higher, these valuation ratios will reset along with the continued progress of increasing revenues, cash flow, debt, book value, etc. Ultimately, growth investors are not as concerned with "value" and are more likely to be the premiums for high growth and demand within an industry.
As technology advances and prices become more affordable, hospitals and medical companies will be more likely to upgrade their current systems or install a new system entirely. Additionally, we are just getting started in the medical device revolution, just imagine what one of these robots will be able to do in 10-20 years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.