With every major U.S. stock index near all-time highs right now, it's not particularly difficult to find equities with questionable valuations. Healthcare stocks, for example, have been ripping higher this year, thanks to stronger-than-expected earnings for many key opinion leaders, as well as the U.S. corporate tax reform that's fueled an uptick in stock buybacks and dividend hikes across the sector.
Buying stocks with valuations not clearly supported by their fundamentals, however, can be bad medicine for your portfolio. With this theme in mind, healthcare investors may want to take a cautious approach when it comes to the high-flying stocks Cronos Group Inc. (NASDAQ:CRON) and Mazor Robotics Ltd. (NASDAQ:MZOR). Here's why.
A red-hot marijuana stock
Thanks to the push to legalize medical, as well as recreational marijuana, in several countries, investors have been piling into speculative marijuana stocks of late. The Canadian marijuana investment firm Cronos Group is a case in point. In 2017, for example, the company's shares gained over 600%.
Cronos also made history earlier this year by becoming the first pure cannabis company to get its stock listed on a major U.S. exchange. That's a big deal because the vast majority of marijuana stocks still trade on the poorly regulated and thinly traded over-the-counter market.
Despite this move to a stock exchange with more liquidity, however, Cronos' ginormous $1 billion market capitalization might not be justifiable. The long and short of it is that investors are obviously banking on Cronos being able to take advantage of Canada's recent decision to approve recreational marijuana.
While this commercial opportunity may turn out to massive, the truth is that Cronos is by far not the only company attempting to grab a piece of this market, and brand-new arenas like this one are notoriously hard to forecast in terms of sales. As a result, there's no truly solid way to project the company's near-term or long-term revenue growth at this early stage.
That being said, Cronos needs to generate at least $200 million a year to bring its valuation in line with the prevailing norm for commercial-stage biotechs (price-to-sales ratio of about 5). The company's trailing-12-month trailing price-to-sales ratio presently stands at an astronomical 217, after all. Unfortunately, Cronos might not be able to achieve that kind of revenue figure until the far larger U.S. market opens up, and that game-changing event remains a pipe dream at this point.
Bottom line: Cronos' shares could revert to the mean if the company's revenue fails to take flight soon.
Another high-priced robotic surgery play
Robotic surgery companies tend to garner enormous premiums and for good reason. Due to the sky-rocketing demand for minimally invasive surgeries, the robotic surgery market is flat-out booming at the moment with a projected compound annual growth rate of 12.3% over the next seven consecutive years, according to a report by Research and Markets.
The Israeli robotic surgery company Mazor Robotics, for instance, presently sports a jaw-dropping forward price-to-earnings ratio of 248. The company's price-to-sales ratio of nearly 20 is also way above average compared to the broader field of revenue-generating healthcare stocks. In fact, Mazor's shares are among the most expensive in the entire healthcare sector -- based on these two classic valuation metrics -- right now.
The glowing optimism surrounding Mazor seems to stem from the company's commercial deal with medical device giant Medtronic (NYSE:MDT). This commercialization agreement is expected to greatly expand, and hence accelerate, the uptake of the Mazor X system. The good news is that sales volumes of the Mazor X system have been picking up since this deal went into effect.
The bad news is that Mazor's top line hasn't benefited all that much from this growing sales base, thanks to the lower pricing points for the Mazor X System under this distribution agreement with Medtronic. Mazor, in fact, missed consensus estimates for both its bottom and top lines in the second quarter of this year.
So, unless Mazor's top-line takes a quantum leap higher with the forthcoming launch of its next-generation system known as the Mazor X Stealth Edition, its shares may struggle to maintain their premium valuation going forward.