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Why Investors Are Paying a Premium For Intuitive Surgical

By Prosper Junior Bakiny - May 9, 2020 at 8:13AM

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The company is facing headwinds, and it's performing slightly worse than the market. Is it worth the price?

Intuitive Surgical (ISRG 2.13%) is currently facing headwinds. Because healthcare systems worldwide are focusing their resources on the fight against COVID-19, many elective surgeries have been delayed or postponed. As a result, Intuitive Surgical's top line could take a hit in the coming quarters. This may explain why the company is performing slightly worse than the stock market so far this year, down 13.6% to the S&P 500's 11.8% decline. Despite its recent slump, though, Intuitive Surgical isn't cheap; its price-to-earnings (P/E) ratio is in line with its peers at 44, while its price-to-earnings-growth (PEG) ratio is 2.1, reflecting a generous valuation.

Is Intuitive Surgical worth the premium? I believe it is, and here's why.

Intuitive Surgical's long-term prospects are attractive 

First, it is worth comparing Intuitive Surgical's performance with that of the broader market over the years. The company's IPO was back in 2000 -- ancient history in the stock market -- and Intuitive Surgical has vastly outpaced the market since then. 

^SPX Chart

^SPX data by YCharts

If Intuitive Surgical can continue putting up such performances -- or anything close to them -- its valuation metrics aren't much of a concern for long-term investors. Of course, past performance isn't a guarantee of anything, so let's turn to Intuitive Surgical's business and see why the healthcare company can continue delivering market-beating returns.

Intuitive Surgical is best known for its signature da Vinci surgical systems, which was first approved by the U.S. Food and Drug Administration (FDA) back in 2000. The devices assist surgeons in their practices, particularly in performing minimally invasive surgeries, which provide several advantages compared to their open-surgery counterparts. These include shorter hospital stays, fewer complications, faster recovery times, and lower costs.

Intuitive Surgical generates revenue by selling its da Vinci systems to healthcare facilities, and it's now sold well over 5,600 of those systems worldwide. However, these devices typically cost between $500,000 and $2.5 million, a small fortune for many hospitals. 

Robotic surgery device.

Image Source: Getty Images.

Fortunately, Intuitive Surgical offers lease arrangements to hospitals that can't afford the up-front payment for a da Vinci system. The company's recurring revenue, which makes up more than 70% of its total, is comprised of revenue from these lease arrangements, as well as the sale of instruments and accessories.

Intuitive Surgical can keep expanding its revenue and earnings for one major reason: The market for robot-assisted surgeries remains severely underpenetrated, and this market will continue to grow for many years to come. For Intuitive Surgical, that means continued sales (and leases) of more and more of its da Vinci Systems, which will help boost its top line.

Also, as the number of surgeries performed with robot assistance grows, the company will sell increasingly more instruments and accessories, which should, again, help the company's revenue growth. Intuitive Surgical also charges support, maintenance, and repair fees for its da Vinci System, so the amount of revenue the company generates from these services will only keep growing, as well. 

What about the competition?

Of course, there will be obstacles in Intuitive Surgical's path. Most notably, the company faces stiff competition in its industry. The pool of Intuitive Surgical's competitors includes such big names as Medtronic (MDT 1.15%) and Johnson & Johnson (JNJ 0.29%). However, most of these competitors are latecomers to the industry, at least when compared with Intuitive Surgical. And as a result, the company has a crucial advantage.

Intuitive Surgical argues that building a robotic surgery device -- as hard as that is to do -- is merely the first step. There are many more hurdles to overcome once that's done, including acquiring approval from health industry regulators, training healthcare workers, building instruments and accessories, and many more. Intuitive Surgical holds a decided lead over its peers when it comes to overcoming these hurdles. For that reason, the company will be able to keep its competitors at bay, or at the very least maintain a solid lead in this market. 

Ignore Intuitive Surgical's valuation

Intuitive Surgical isn't cheap, but the company's potential isn't fully baked into its valuation metrics just yet, either. Intuitive Surgical still has a lot of room to grow, and it could continue beating the market for a long time. Investors who purchase shares of Intuitive Surgical today will likely be glad they did so in five years. 

Prosper Junior Bakiny has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Intuitive Surgical. The Motley Fool recommends Johnson & Johnson. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Intuitive Surgical, Inc. Stock Quote
Intuitive Surgical, Inc.
ISRG
$237.85 (2.13%) $4.97
Johnson & Johnson Stock Quote
Johnson & Johnson
JNJ
$170.67 (0.29%) $0.49
Medtronic plc Stock Quote
Medtronic plc
MDT
$94.17 (1.15%) $1.07

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