What are the most expensive large-cap healthcare stocks on the market? It depends on how you define expensive.
You could just look at the share price. However, that's more a factor of how many shares a company has issued than it is a measure of the true valuation of a stock. Some people might look at the trailing-12-month price-to-earnings (P/E) ratio. But that metric doesn't accurately assess the valuation of stocks with fast-growing earnings. It also could be skewed by a one-time impact to earnings over the last 12 months.
Although it's still an imperfect measurement, I think we can use the forward price-to-earnings multiple to compare healthcare stocks to identify the most expensive. Using this metric, three healthcare stocks appear at the top of the list: Abiomed (NASDAQ:ABMD), Align Technology (NASDAQ:ALGN), and Illumina (NASDAQ:ILMN). But are these expensive healthcare stocks really worth their hefty price tags?
Abiomed stock trades at a whopping 85 times expected earnings. And that's well below Abiomed's trailing-12-month P/E ratio of 140. Why does the stock trade at such a premium?
The company's minimally invasive heart pumps are racking up record sales. In Abiomed's Q3 results reported in February, revenue for the company's Impella heart pumps jumped 36% worldwide. International sales soared 94%, thanks largely to rapid growth in Germany.
Wall Street analysts project that Abiomed will grow earnings by 38% annually over the next five years. That doesn't seem far-fetched at all. Impella heart pumps are used in only 9% of high-risk Percutaneous Coronary Intervention (PCI) procedures in the U.S. Even with strong growth in Germany, Abiomed thinks that it only has a market share of around 12%. Other countries, including Japan, also present great growth opportunities.
Abiomed is also developing new circulatory support products and making enhancements to its existing products. The company's plan is to "develop a complete portfolio of products across the continuum of care in heart recovery." Abiomed does face competition, however, both from other medical device makers and from pharmaceutical companies, which could develop drugs that reduce the need for PCI procedures.
2. Align Technology
Align Technology forward earnings multiple of nearly 44 is a lot less than Abiomed's, but it's still very high compared to most stocks. As is the case with Abiomed, though, there's a reason behind Align's lofty valuation.
Demand for Align's Invisalign clear dental aligners has skyrocketed so much that Align ranked as the best-performing stock in the S&P 500 index last year. Invisalign helps straighten teeth like metal-and-wire braces do, but they're practically invisible.
There are several ways that Align can continue its remarkable growth. First of all, the company only claims around 11% of the current addressable market of orthodontic cases. The figure is even lower for the teen market, where Align has a market share of roughly 4.5%. Align should be able to capture more of the current market through marketing and international expansion.
However, Align's strategy isn't to limit itself to the current addressable market. The company is developing new technology that should enable clear aligners to treat more serious types of malocclusion (misalignment of teeth). Align thinks these efforts will expand the addressable market from 6 million orthodontic cases annually to around 8.5 million.
Illumina stock currently trades at just under 44 times expected earnings. That sky-high multiple isn't abnormal for the gene-sequencing pioneer.
Gene sequencing has opened the door to a new era in treating genetic diseases. Illumina was at the forefront, with its technology helping lower the cost for mapping a human genome from $200,000 in 2009 to around $1,000 five years later. The company's introduction of its NovaSeq system last year offers the potential to reduce the cost to $100 in the future.
The NovaSeq launch has exceeded Illumina's expectations so far, attracting many customers who are completely new to gene sequencing. Illumina expects most of its existing customers who use its high-throughput HiSeq gene-sequencing system will transition to NovaSeq over the next few years. That should mean the company can count on sustained sales growth for a while to come.
But what about Illumina's long-term future? It, too, should be bright. A greater focus on precision medicine -- the customization of care to an individual's genetic profile -- will require more gene sequencing. Illumina has rivals, but it's investing heavily in innovation to make sure it stays on top.
Are these stocks too expensive?
There's no question that Abiomed, Align, and Illumina are expensive stocks. But are they too expensive? That's a tougher question to answer.
I think there are two other questions that should be posed. First, can the companies continue to grow sales and earnings significantly? Second, will the high relative valuations of the stocks be likely to inhibit the stocks from moving higher?
My view is that Abiomed, Align, and Illumina can each definitely continue to grow sales and earnings at impressive levels. I think that Align Technology should even be able to grow at faster rates over the next few years than it has recently. In mu opinion, high valuations shouldn't be too problematic for any of these stocks, either. Illumina's forward earnings multiple is actually on the low end of the stock's historical range.
Had we asked if Abiomed, Align, and Illumina were too expensive a year ago, the answer would have been "yes" for some. And those investors would have missed out on Abiomed and Align Technology stocks more than doubling, with Illumina stock jumping 34%. The bottom line is that, while these three stocks might be too expensive for some investors, they're clearly not too expensive for many investors, because their share prices keep on rising.