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In early May, I pitted medical conglomerate Johnson & Johnson (JNJ +0.43%) against robotic-surgery specialist Intuitive Surgical (ISRG 1.14%) to see which company was a better buy at the time. In the end, I called it a draw. Since then, Johnson & Johnson has edged Intuitive Surgical out by a hair, with an 11% return versus a 9% return, respectively.
Those are only short-term moves that tell us little to nothing about these companies' long-term potential. However, since both companies recently reported earnings that investors were pretty happy with, it's time to revisit these two and see if anything has changed.
Financial fortitude
Cash isn't sexy. It doesn't lead to growth, and if it's sitting on the balance sheet, its not being returned to shareholders. But cash is vitally important for those times we don't like to think about -- the downturns.
Whether there's a company-specific crisis or an industrywide catastrophe, those companies that have cash lying around have lots of options when times get tough. They can continue supporting their business uninterrupted, they can outspend their competitors on growth opportunities, they can buy back shares of their company on the cheap, or they can even make strategic acquisitions of rivals.
Here's how Intuitive Surgical and Johnson & Johnson now stack up in terms of financial fortitude:
| Company |
Cash, Short and Long-Term Investments |
Debt |
Net Income |
Free Cash Flow |
|---|---|---|---|---|
|
Intuitive Surgical |
$4.2 billion |
$0 |
$68 million |
$85 million |
|
Johnson & Johnson |
$42 billion |
$26 billion |
$14.9 billion |
$14.6 billion* |
Data source: SEC filings, Yahoo! Finance, Company conference calls. *In its initial earnings release, Johnson & Johnson did not include cash flow information. This figure represents the past four quarters for which we have information.
It should be noted that Intuitive Surgical's cash figure is markedly higher than it was in my May installation. That's because 1) the company has increased free cash flow by 58% through the first six months of the year to $437 million, and 2) I failed to include marketable securities.
During the company's most recent conference call, Intuitive's management said there were many options for its growing cash stash, including strategic acquisitions, increasing R&D spending, share repurchases, or even a dividend.
Although Johnson & Johnson is by no means in trouble, it can't match Intuitive Surgical's balance sheet, which has no long-term debt.
Winner = Intuitive Surgical
Sustainable competitive advantage
Over the long run, there's probably no factor more important in determining the success of a business than its sustainable competitive advantages.
Johnson & Johnson has several. Within its consumer products division, the company relies on the strength of its brands, like Band-Aid and Tylenol. Although competitors can offer the same product for less, consumers are more familiar with these brand names, and it gives Johnson & Johnson a measure of pricing power.
In the company's medical-devices division, the base of installed products, as well as its brand names, provide something of a moat -- although this is a quickly evolving industry. And in Johnson & Johnson's pharmaceutical division, the patents that protect the company's compounds block any cheaper alternatives for a specified number of years.
Intuitive Surgical's advantage mainly comes from its first-mover status and massive installed base of 3,745 daVinci systems worldwide. That type of head start, and the collective knowledge that's been accumulated from working on the systems, is a formidable obstacle to competition.
I think Intuitive's advantages are greater than any one of the three offered by Johnson & Johnson's divisions. But when you consider Johnson & Johnson's business units as a whole, I think it's safest to say this is still a draw. Both companies have moderately strong sustainable competitive advantages.
Winner = Tie
Valuation
There are lots of ways to measure a stock's valuation. Here are four of my favorites:
| Company |
P/E |
P/FCF |
P/S |
PEG Ratio |
|---|---|---|---|---|
|
Intuitive Surgical |
33 |
31 |
10.5 |
2.3 |
|
Johnson & Johnson |
20 |
24* |
4.9 |
2.9 |
Data source: Yahoo! Finance, E*Trade. Non-GAAP EPS used to calculate P/E. *FCF for the four most recent reportable quarters used in calculation
By most measures, Johnson & Johnson looks demonstrably cheaper. The company trades for a lower price-to-earnings and price-to-free-cash-flow ratio. But when predictions for growth are taken into consideration -- via the PEG Ratio -- we see a slightly different story. Intuitive Surgical appears to be 20% cheaper based on its potential for future growth.
Either way, I believe that both stocks are pretty richly valued relative to their growth prospects. Johnson & Johnson currently offers a 2.6% dividend yield, which shouldn't be ignored. But Intuitive Surgical's continued growth in procedures -- mainly in hernia and colorectal operations -- has me thinking there are some impressive years ahead. I call it a tie.
Winner = Tie
So there you have it. Three months ago, I called this a tie. While the two companies came up even in two out of three categories this time around, the scales tilt slightly in favor of Intuitive Surgical. The reason is clear: I no longer think Intuitive is ridiculously expensive when compared to Johnson & Johnson; I think they're equally expensive!
No doubt there's nothing wrong with owning Johnson & Johnson shares. But I think you'll get the best bang for your long-term buck with Intuitive today.
