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IHI: Overvaluation Offsets Bullish Health Care Fundamentals For Medical Devices ETF


  • Medical Devices ETF (IHI) has handily outperformed broader markets over the past 10 years.
  • Weighted average price-to-book ratio on IHI's top 10 holdings surpassed the most expensive level since 2004 just ahead of the virus-driven correction.
  • Subpar revenue growth and return on equity along with overvaluation suggest upside potential in IHI is limited.
  • We expect health care ETF (XLV) to outperform going forward considering XLV's more moderate multiples and robust earnings.

iShares US Medical Devices ETF (NYSEARCA:IHI) crumbled alongside broader markets on an escalating global Covid-19 contagion, with a roughly -10% year-to-date performance which is mostly inline with S&P 500 (SPY) and health care sector (XLV). On a longer-term basis, IHI has been a stellar outperformer, particularly since 2017 when IHI took off and has been ahead of the pack:

Source: WingCapital Investments

Rich Valuations & Slowing Earnings Growth: 2 Headwinds Facing IHI

Ever-increasing demand for new technologies and products due to aging populations in developed countries as well as health care expansion in emerging markets has certainly led to the tremendous gains in medical devices companies. While macro fundamentals will undoubtedly continue to be favorable for IHI, overvaluation warrants caution as the price-to-book ratio of its top 10 holdings had turned most elevated since 2004 as of end of last year:

Symbol Name % Weight P/B as of 3/31/2004 P/B as of 12/31/2019 P/B as of 3/2/2020
ABT Abbott Laboratories 12.75% 4.92 4.83 4.54
MDT Medtronic PLC 12.33% 6.73 3.09 2.66
TMO Thermo Fisher Scientific Inc 10.85% 2.0 4.37 4.1
DHR Danaher Corp 7.96% 3.85 3.72 3.66
BAX Baxter International Inc 4.65% 5.35 5.35 5.69
SYK Stryker Corp 4.63% 7.74 6.14 5.77
ISRG Intuitive Surgical Inc 4.46% 1.99 8.26 7.81
BDX Becton, Dickinson and Co 4.37% 4.07 3.48 3.14
EW Edwards Lifesciences Corp 4.35% 3.34 11.76 10.73
BSX Boston Scientific Corp 4.07% 11.26 6.5 3.84
IHI Top 10 70.42% 4.91 5.11 4.66

Source: TIKR.com, WingCapital Investments

A correspondingly high profitability certainly would justify the increase in price-to-book ratios, though that does not appear to be the case for IHI. Specifically, return on equity on the top 10 holdings collectively is a mediocre 15%, which in fact is no higher than 2004 albeit rising steadily the past few years:

This article was written by

Quantitative Strategies utilizing Empirical Analysis, Pattern Recognition and Statistical Arbitrage techniques. Identifies high-probability long/short opportunities with short-medium term horizon in large caps, ETFs, commodities and FX. Macro Commentary and Market Research.

Analyst’s Disclosure: I/we 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.

We may have options, futures or other derivative positions in the above tickers mentioned.

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