Every well-balanced portfolio needs a healthcare stock in it. Within that industry, there's a very profitable niche for medical device makers. Two of the leading names in that area are Intuitive Surgical (ISRG +0.90%), maker of the da Vinci surgical robot, and Accuray (ARAY +11.17%), which makes the CyberKnife, a radiation delivery tool for cancer patients.
Today, we'll be investigating which of these two stocks is a better buy for your portfolio. I first ran these two against each other three years ago, with Intuitive Surgical coming out on top. The results since then: Accuray has lost one-quarter of its value, while Intuitive Surgical's has tripled!
Image source: Getty Images.
While there's no bulletproof way to pick the "better" stock, we'll compare each on three vital characteristics and see which is left standing at the end.
Financial fortitude
When you invest in a medical device maker, you want to know it can survive tough times. Hospital budgets can tighten, products can malfunction, and trends can change. If there's no buffer in terms of financial fortitude, the company you've invested in could face very difficult times.
Keeping in mind that Intuitive Surgical is valued at almost 200 times the size of Accuray, here's how they stack up.
| Company | Cash | Debt | Free Cash Flow |
|---|---|---|---|
| Intuitive Surgical | $4.5 billion | $0 | $1 billion |
| Accuray | $69 million | $129 million | $5 million |
Data source: Yahoo! Finance. Cash includes long- and short-term investments. Free cash flow presented on trailing 12-month basis.
Even after accounting for the size difference, Intuitive Surgical wins this contest in a landslide. The fact that Accuray has a negative cash position and is barely free cash flow positive does not bode well for the company.
Shareholders of Intuitive Surgical, on the other hand, have seen their company's cash balance surge over the past four years -- and have enjoyed the benefit of rather large share repurchases.
Winner = Intuitive Surgical
Valuation
Next we have valuation. But don't get your hopes up about easily determining which stock is "cheaper." This isn't an exact science, and we'll only know in hindsight if today's prices are truly a bargain. That said, to get a more holistic picture, I like to consult a number of different metrics.
| Company | P/E | P/FCF | P/S | PEG Ratio |
|---|---|---|---|---|
| Intuitive Surgical | 53 | 60 | 16.8 | 3.1 |
| Accuray | 10 | 65 | 0.8 | 0.1 |
Data source: Yahoo! Finance, E*Trade. P/E presented on non-GAAP earnings basis when applicable.
On all but one metric, Accuray is demonstrably cheaper. This shouldn't be too surprising. As I'll dive into below, Intuitive Surgical has performed exceptionally well over the past four years. Accuray has not.
The flip side of that dynamic is that Intuitive's stock has high expectations baked in. Accuray's is priced as though the company won't last much longer. At the slightest hint of good news, Accuray's stock could soar.
Realize this doesn't mean Accuray's stock will soar. But it does add a margin of safety that gives the stock an edge here.
Winner = Accuray
Sustainable competitive advantages
Finally, we have what I consider to be the most important facet to evaluate: sustainable competitive advantages -- otherwise known as a company's "moat." Over the long run, companies with a wide moat keep customers coming back again and again while holding the competition at bay.
Intuitive Surgical benefits from two huge moats. The first is high switching costs. There are currently more than 4,000 da Vinci machines installed globally, with in excess of 40,000 doctors having trained on the platform. Each machine costs over $1 million, and each doctor devotes countless hours to learning how to use it. In both cases, switching to another platform would incur enormous costs -- both financial and emotional.
The second benefit comes from the network effect: Intuitive Surgical becomes more valuable for users with each new user. That's because -- over the long run -- more surgeons means more tinkering with the da Vinci's use in new procedures. That tinkering eventually leads to huge breakthroughs -- like the one we're currently seeing with hernia procedures. It helps explain why the company was able to grow procedures so much last year -- and why it expects to do the same in 2019.
Accuray, on the other hand, has had a much tougher time gaining such traction. Part of that could be because the CyberKnife cost hospitals more than twice as much ($3.1 million) when it debuted in 2013. When that's the case, switching costs are still high, but that only matters if hospitals adopt your platform en masse. With growth rarely entering double-digit territory, that simply hasn't been the case.
As such, Intuitive has a much wider and stronger moat.
Winner = Intuitive Surgical
My winner is...
So there you have it. While Accuray has such a low price that it could post big short-term gains on the slightest bit of news, Intuitive is -- in my opinion -- the better long-term bet. It has a much stronger balance sheet and a wider moat.
That helps explain why the company occupies more than 4% of my real-life holdings, while I've never owned a share of Accuray. If you're looking to add a medical device stock to your own portfolio, I suggest you consider the same strategy.
Check out the latest Intuitive Surgical and Accuray earnings call transcripts.
