Is Intuitive Surgical's Stock Expensive or Cheap by the Numbers?

Numbers can lie -- yet they're the best first step in determining whether a stock is a buy. In this series, we use some carefully chosen metrics to size up a stock's true value based on the following clues:

  • The current price multiples.
  • The consistency of past earnings and cash flow.
  • How much growth we can expect.

Let's see what those numbers can tell us about how expensive or cheap Intuitive Surgical (Nasdaq: ISRG  ) might be.

The current price multiples
First, we'll look at most investors' favorite metric: the P/E ratio. It divides the company's share price by its earnings per share (EPS) -- the lower, the better.

Then we'll take things up a notch with a more advanced metric: enterprise value to unlevered free cash flow, which divides the company's enterprise value (basically, its market cap plus its debt, minus its cash) by its unlevered free cash flow (its free cash flow, adding back the interest payments on its debt). As with the P/E, the lower this number is, the better.

Analysts argue about which is more important -- earnings or cash flow. Who cares? A good buy ideally has low multiples on both.

Intuitive Surgical has a P/E ratio of 37.6 and an EV/FCF ratio of 33.5 over the trailing 12 months. If we stretch and compare current valuations with the five-year averages for earnings and free cash flow, we see that Intuitive Surgical has a P/E ratio of 65.7 and a five-year EV/FCF ratio of 54.4.

A positive one-year ratio of less than 10 for both metrics is ideal (at least in my opinion). For a five-year metric, less than 20 is ideal.

Intuitive Surgical is 0-for-4 on hitting the ideal targets, but let's see how it stacks up against some of its competitors and industry mates (MAKO Surgical may be the best comp, but I excluded it here because none of its price multiples are meaningful because of losses). 

Company

1-Year P/E

1-Year EV/FCF

5-Year P/E

5-Year EV/FCF

Intuitive Surgical 37.6 33.5 65.7 54.4
Medtronic (NYSE: MDT  ) 12.0 11.7 13.7 13.0
Stryker (NYSE: SYK  ) 15.3 15.2 16.6 15.6
CR Bard (NYSE: BCR  ) 21.5 11.4 18.6 14.1

Source: S&P Capital IQ; NM = not meaningful because of losses.

Numerically, we've seen how Intuitive Surgical's valuation rates on both an absolute and relative basis. Next, let's examine ...

The consistency of past earnings and cash flow
An ideal company will be consistently strong in its earnings and cash-flow generation.

In the past five years, Intuitive Surgical's net income margin has ranged from 21.4% to 28.2%. In that same time frame, unlevered free cash flow margin has ranged from 21.4% to 31.6%.

How do those figures compare with those of the company's peers? See for yourself:

Source: S&P Capital IQ; margin ranges are combined.

Source: S&P Capital IQ; margin ranges are combined.

In addition, over the past five years, Intuitive Surgical has tallied up five years of positive earnings and five years of positive free cash flow.

Next, let's figure out ...

How much growth we can expect
Analysts tend to comically overstate their five-year growth estimates. If you accept them at face value, you will overpay for stocks. But even though you should definitely take the analysts' prognostications with a grain of salt, they can still provide a useful starting point when compared with similar numbers from a company's closest rivals.

Let's start by seeing what this company's done over the past five years. In that time period, Intuitive Surgical has put up past EPS growth rates of 35%. Meanwhile, Wall Street's analysts expect future growth rates of 19.7%.

Here's how Intuitive Surgical compares with its peers for trailing-five-year growth:

Source: S&P Capital IQ; EPS growth shown.

Source: S&P Capital IQ; EPS growth shown.

And here's how it measures up with regard to the growth analysts expect over the next five years:

Source: S&P Capital IQ; estimates for EPS growth.

Source: S&P Capital IQ; estimates for EPS growth.

The bottom line
The pile of numbers we've plowed through has shown us the price multiples that shares of Intuitive Surgical are trading at, the volatility of its operational performance, and what kind of growth profile it has -- both on an absolute and a relative basis.

The more consistent a company's performance has been and the more growth we can expect, the more we should be willing to pay. We've gone well beyond looking at a 37.6 P/E ratio, and we see that Intuitive Surgical is a profitable growth stock. It sells for high price multiples, but it shows high margins and high past and expected future growth. I continue to hold Intuitive Surgical because I like its proven profitability and the potential of robotic surgery.

I bought in on a dip a few years ago, and my bar for holding is lower than purchasing shares at today's price, but Intuitive Surgical is currently a "Best Buy Now" of our Motley Fool Rule Breakers newsletter service (so is MAKO Surgical). If you find Intuitive Surgical's numbers or story compelling, don't stop here. Continue your due-diligence process until you're confident one way or the other. As a start, add it to My Watchlist to find all of our Foolish analysis.

You can also see the stocks that I've researched beyond the initial numbers and bought in my public real-money portfolio.

Anand Chokkavelu owns shares of Intuitive Surgical. The Motley Fool owns shares of Medtronic. Motley Fool newsletter services have recommended buying shares of Stryker, Intuitive Surgical, and MAKO Surgical. Try any of our Foolish newsletter services free for 30 days. 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 (1) | Recommend This Article (7)

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 November 20, 2011, at 11:57 AM, MrZ2357 wrote:

    There is a lot to like about this company.

    It is one of my major holdings.

    There is one thing that worries me however.

    That being the large amount of money authorized for share buyback.

    Surely there is better uses for that money than buying back shares at record valuations.

    Like looking into buying MAKO for example.

    If there is no immediate use for the money then what is wrong with leaving it in the bank.

    I mean, are management like teenagers where money in the pocket burns a hole?

    I am wondering if this buyback is to soak up the additional shares generated through stock options. 1 millions additional shares per year i believe.

    That is a high price to pay for anti dilution. I would suggest, dilute less. $500Million dilution/year.

    Still I would be happier with that money in the companies bank rather than buying back shares.

    I've seen many companies buy back shares, only to turn around and issue shares at a lower price when things dont go well.

    Hopefully that wont happen here, but why take that chance when they dont have to?

    I am a big fan of the way apple handles this.

    No dividend, no buybacks, accumulate cash and spend as appropriate to improve the business.

    What do others think?

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