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Phase 2 for Intuitive Surgical

So how much would you spend for a company that can dramatically alter the way surgeries are performed and has no credible competitor on the horizon? 30 times earnings? 50? Do I hear 100? That's the problem facing Rule Breakers recommendation Intuitive Surgical (Nasdaq: ISRG  ) today -- a good company with a very good product that has seen its stock become a momentum darling.

Robots and accessories continued a steady march out the door this past quarter, with revenue up 60% over last year's level. Not only did the company sell 60% more systems (40 versus 25), but instrument and accessory revenue was up 78%. Gross margins rose again, operating margin took a big jump, and operating income more than doubled.

All of that's just fine -- but the company's guidance for 2006 might rattle some of the market's more hyperactive traders. Management is looking for revenue growth between 25% and 35%, while the Street was pegging an average revenue growth estimate of around 37%. Couple that with some insider sales at Intuitive Surgical over the past few months, and some people may get skittish.

Those aren't the bits that I'm paying attention to right now, though. What interests me is how the company transitions to the next phase of its growth. It's had a good initial run with the DaVinci system, and it's built a good share of the prostatectomy market. Now it's time to move on and push for penetration in other surgical specialties like cardiology, gynecology, and general surgery. After all, there's only so much money to be made in prostate surgery.

I've been a fan of Intuitive Surgical for a long time -- even back when the sell-side firm I worked for supported and did investment banking for a rival (since acquired by Intuitive). But when I see analysts coming out and basing price targets on 70 times earnings, that's just nutty. Heck, most medical technology CEOs are very happy if they can sell their companies to Medtronic (NYSE: MDT  ) , Abbott (NYSE: ABT  ) , or Boston Scientific (NYSE: BSX  ) for eight to ten times sales. Intuitive trades at nearly 20 times sales.

I'm certainly not saying that Intuitive can't continue to grow and further penetrate the surgery market. There really is a huge market opportunity out there. Still, when a company already has this big a following, I tend to turn a bit suspicious -- particularly when analysts seem to start using the "today's price plus 20%" method of valuation. By no means am I saying "sell," but do be careful out there.

For more med-tech Takes:

Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).

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