Time to Sell Varian Medical Systems?

Should you sell Varian Medical Systems (NYSE: VAR  ) today?

The decision to sell a stock you've researched and followed for months or years is never easy. But if you fall in love with your stock holdings, you risk becoming vulnerable to confirmation bias -- listening only to information that supports your theories, and rejecting any contradictions.

In 2004, longtime Fool Bill Mann called confirmation bias one of the most dangerous components of investing. This warning has helped my own investing throughout the Great Recession. Now I want to help you identify potential sell signs on popular stocks within our 4-million-strong Fool.com community.

Today I'm laser-focused on Varian Medical Systems, ready to evaluate its price, valuation, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, Varian has risen by 40.6% versus an S&P 500 return of 11.3%.  Investors have every reason to be proud of their returns, but is it time to take some off the top?  Not necessarily. Short-term outperformance alone is not a sell sign. The market may be just beginning to realize Varian's true, intrinsic value.'For historical context, let’s compare Varian's recent price with its 52-week and five-year highs. I've also included a few other businesses in the same industry or a related one.

Company

Recent Price

52-Week High

5-Year High

Varian $65.73 $65.92 $65.92
Intuitive Surgical (Nasdaq: ISRG  ) $254.45 $393.92 $393.92
CR Bard (NYSE: BCR  ) $85.04 $90.00 $101.60
Boston Scientific (NYSE: BSX  ) $6.50 $9.79 $27.80

Source: Capital IQ, a division of Standard & Poor's.

Varian is basically at its 52-week high, so we need to dig into the valuation to ensure that these previously untested highs are justified.

Potential sell signs
First up, we'll get a rough idea of Varian's valuation. I'm comparing Varian's recent P/E ratio of 22.2 with where it's been over the past five years. 

 

Varian's P/E is lower than its five-year average, a possible indication that the stock is undervalued. A low P/E isn't always a good sign, since the market may be lowering its valuation of the company because of less attractive growth prospects. But it does indicate that, on a purely historical basis, Varian looks cheap.

Now let's look at the gross-margin trend, which represents the amount of profit a company makes for each $1 in sales, after deducting all costs directly related to that sale. A deteriorating gross margin over time can indicate that competition has forced the company to lower prices, that it can't control costs, or that its whole industry's facing tough times. Here's Varian's gross margin over the past five years.

 

Varian is having no trouble maintaining its gross margin, which tends to dictate a company's overall profitability. That's solid news; however, investors need to keep an eye on this metric over the coming quarters. If margins begin to dip, you'll want to know why.

Next, let's explore what other investors think about Varian. We love the contrarian view here at Fool.com, but we don't mind cheating off our neighbors every once in a while. For this portion of our research, we'll examine two metrics: Motley Fool CAPS ratings and short interest. The former tells us how Fool.com's 170,000-strong community of individual analysts rates the stock, and the latter shows what proportion of investors is betting that the stock will fall. I'm including other peer companies once again for context.

Company

CAPS Rating (out of 5)

Short Interest (% of Float)

Varian 5 4.4%
Intuitive Surgical 4 6.5%
CR Bard 4 4.2%
Boston Scientific 3 3.3%

Source: Capital IQ, a division of Standard & Poor's.

The Fool community is rather bullish on Varian. We typically like to see our stocks rated at four or five stars. Anything below that level is a less-than-bullish indicator.  I highly recommend that you visit Varian's stock-pitch page to see the verbatim reasons behind the ratings.

Here, short interest is at a mere 4.4%. A number like this typically indicates that few large institutional investors are betting against the stock.

Now let's study Varian's debt situation, with a little help from the debt-to-equity ratio. This metric tells us how much debt the company's taken on, relative to its overall capital structure.

 

Varian has done a good job of reducing its debt over the past five years. With total equity increasing over the same time period, debt-to-equity has consequently decreased, as the above chart shows. Based on the trend alone, that's a good sign. I consider a debt-to-equity ratio below 50% to be healthy, though the number varies by industry. Varian is currently below this level, at 3.4%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If Varian had to convert its current assets to cash in one year, how many times over could it cover its current liabilities? As of the last filing, the company had a current ratio of 1.86. That's a healthy sign. I like to see companies with current ratios equal to or greater than 1.5.

Finally, it's highly beneficial to determine whether Varian belongs in your portfolio -- and to know how many similar businesses already occupy your stable of investments. If you haven't already, be sure to put your tickers into Fool.com's free portfolio tracker, My Watchlist. You can get started right away by adding Varian.

The final recap

 

Varian has failed none of the quick tests that would make it a sell. That's great, but does it mean you should hold your Varian shares? Not necessarily. Just keep your eye on these trends over the coming quarters.

Remember to add Varian to My Watchlist to help you keep track of all our coverage of the company on Fool.com.

If you haven't had a chance yet, be sure to read this article detailing how I missed out on more than $100,000 in gains through wrong-headed selling.

Intuitive Surgical is a Motley Fool Rule Breakers choice. Try any of our Foolish newsletter services free for 30 days.

Jeremy Phillips owns no shares of the companies mentioned.  We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 05, 2010, at 4:31 AM, exdividendday wrote:

    Varian Medical Systems is engaged in the design, manufacture, sale and service of equipment and software products for treating cancer with radiotherapy, stereotactic radiosurgery and brachytherapy.

    The company generated sales in an amount of USD 2.35 billion in fiscal 10/10 and a net income of USD 0.36 million. Sales grew by the factor of 3 and net income by 5.7 over the past decade. That is a track record due to the fact, that the company increased no long-term debt and repurchased own shares. VAR is valuated at USD 8.2 billion and pay no dividends. For a stock that have double digit growth rates in sales and earnings, no long-term debt and USD 370 million expected income – payable! Despite all, I know stocks from the healthcare sector that are ten times bigger and have similar ratios. It could be possible that VAR could receive one day an attractive takeover offer maybe from BSX, COV or BAX. But those stocks are too small. JNJ has more buying power. Here is a sheet of 8 medical equipment and supplies stocks with highest dividend yield:

    http://long-term-investments.blogspot.com/2010/09/highest-di...

    The average dividend-yield amounts to 2.99 percent while the average P/E ratio is 15.98.

  • Report this Comment On December 07, 2010, at 2:42 PM, PauvrePapillon wrote:

    Varian has a large installed base and the political clout that goes with it. They have been able to use their “research grants” and other lobbying efforts to manipulate multiple Certificate of Need (CON) processes as well as CMS code designations and ASTRO positions and thus delay the wider adoption of competing treatments; however, they have one major problem. Their basic technology is inferior, perhaps even obsolete, and new advances in imaging technologies are beginning to make this fact ever more obvious.

    The basic problem is that all of Varian’s various radiation devices ("various devices" meaning in reality various marketing names) rely on large, heavy linear accelerators that are mounted on large, heavy gantries and therefore are only capable of moving (essentially rotating) around a single plane. This allows their radiation devices to fire at a target from two to seven different angles or directions.

    Accuray Incorporated (ARAY) has introduced a proprietary miniature linear accelerator which is small and light enough to be incorporated into a robotically controlled system which allows their device (the CyberKnife) to fire at its target from 100 to 200 different angles or direction.

    Accuray has moved radiation delivery from a two-dimensional paradigm into a three-dimensional one.

    Why is this important?

    To understand why this is a game changer you first need to understand just a few basics about therapeutic radiation.

    First, with a sufficient dose, any living tissue can be destroyed. Put enough radiation on it and it dies. The trick is: how do we get enough radiation on the target without burning a hole through the patient.

    Second, there are critical structures (such as the spinal cord, the chest wall, the bladder, the optic nerve, etcetera) which you need to avoid altogether.

    Third, there are always toxicities associated with therapeutic radiation; therefore, minimizing doses to healthy tissues (and avoiding critical structures) is always important... at least to the patient if not the doc.

    Fourth, radiation passes completely through the body. A beam fired from one angle will penetrate the body and go in one side and out the other. The reason the tumor (or other target) is destroyed is because it gets a higher dose than surrounding tissue due to the cumulative effect of multiple convergent beams.

    Here is where CyberKnife’s competitive advantage becomes quite apparent. Just to keep the math simple, if we have five beams converging on a target and each beam fires 5 Gys, in one session we can drop in 25 Gys on the tumor while the surrounding tissue will receive a dose of only 5 Gys.

    But now what happens if we can fire from 100 angles? Again, keeping the math simple, we can now drop in 25 Gys with beams holding a dose of only 0.4 Gys. Thus the radiation delivery “drop off” is greatly enhanced and the surrounding healthy tissue is spared. The greater drop off also allows CyberKnife to effectively attack tumors located proximate to critical structures.

    Further, Accuray has leveraged its three dimensional capability to develop a system that tracks, detects and corrects for tumor movement in real time. This feature is extremely important because extracranial tumors move due to respiration, gastrointestinal processes and other factors.

    Varian, true to form, has lifted Accuray’s press releases (in some cases word for word) and claimed that its TrueBeam (trademark of the month) system can also track for tumor movement.

    However, they are playing the investment community for fools. Obviously, a device which itself is only capable of moving in two dimensions cannot possibly correct for tumor movement which occurs in three. Nevertheless, this is what Varian management has claimed and continues to claim and will continue to claim until some analyst on some quarterly conference calls wakes up and goes, “Hey, wait a minute…”

    New diagnostic software is being introduced that allows MRI images to be read in such a manner as to predict the occurrence and location of microscopic disease that could not otherwise be seen or located. Dr. Don Fuller (San Digeo) is already using these images to create customized radiation treatment patterns using CyberKnife for prostate cancer in both stereotactic radiosurgical (SRS) and intensity modulated radiotherapy (IMRT) treatment modalities.

    This is the future of cancer imaging and treatment, i.e., greater accuracy and precision both in the imaging and treatment phase. But only Accuray’s CyberKnife has the accuracy and precision necessary to take advantage of this new imaging data.

    Varian is still attacking tumors with 1950s style gantry-mounted radiation sprayers and are so far behind Accuray’s trailblazing development curve that they don’t even have a miniature linear accelerator much less a robotic guidance and control system to put it in.

    A lot of Varian shareholders make big noises about Dr. John Adler (the neurosurgeon and Accuray founder who had the initial idea to liberate the radiation source from the gantry) joining Varian as VP Clinical Applications. What they are missing is that while Adler provided the initial concept for CyberKnife, he never had (and still doesn’t have) the technical background or genius to actually build a gantry-mounted system much less a robotically controlled one.

    That distinction belongs to the late Dr. Russell Schonburg who invented the miniature linac, Dr. Joseph Depp who designed the three dimensional guidance system and Dr. Mohan Budduluri who combined Dr. Schonburg’s linac with Dr. Depp’s guidance system and actually made the thing work.

    And all that was years ago. Today’s CyberKnife is a highly evolved and advanced robotic system which is so far ahead of Varian’s gantry-mounted systems as to have a technological mote which is insurmountable in even the distant future.

    The bottom line here is that Varian has a huge advantage in terms of installed base and docs and hospitals with vested interests tied to that base.

    Accuray has a huge technological advantage which, at some point, Varian’s campaign of obfuscation notwithstanding, is going to become obvious to everyone including the patient community.

    When that happens, who is going to want to be treated with a gantry-mounted radiation sprayer?

  • Report this Comment On December 07, 2010, at 2:46 PM, PauvrePapillon wrote:

    Oops... That 0.4 Gys above should be 0.25 Gys.

    Anyway, the point is the same only more so.

  • Report this Comment On December 17, 2010, at 5:49 PM, ironyworks wrote:

    Paubvre; Excellent submission..thanks!

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