In 2000, Intuitive Surgical (ISRG 0.71%) went public at $9 per share and launched its da Vinci surgical system. The company's focus on improving medical outcomes and reducing hospitalization and recovery times has benefited patients around the world -- and worked wonders for shareholders.
And for investors who missed out on those first couple decades of gains, it's not too late to buy in: Intuitive Surgical's global installed base of robots and the recurring revenue they generate has it set to keep delivering market-beating returns for the foreseeable future.
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Incredible returns through ups and downs
An investor who was able to pick up $1,000 worth of Intuitive Surgical shares at its IPO price and held on has seen that investment grow to a whopping $122,500.
To capture that remarkable return, shareholders would have had to endure several precipitous drops. The stock lost about three-quarters of its value twice in its first decade as a public company, and has dropped by more than a third twice in the past 10 years. It's a valuable lesson about the volatility that investors must learn to endure if they want to achieve legendary wins.
Over the years, the company's hardware and business dealings have also generated some controversy. In 2013, safety concerns surfaced about the da Vinci system, among them the possibility of electrical arcing that could injure patients. That issue in particular resulted in a warning letter from the U.S. Food and Drug Administration (FDA). In 2018, a report found 2,000 adverse events associated with the devices, including a dozen in which the FDA allowed the company to bundle as many as 200 complaints into one "event" because of class action litigation.
That same report found that Intuitive Surgical paid hospitals and doctors more than $144 million for travel, research, and teaching. Most eye-raising, a study in July of that year made the connection between the financial incentives and the likelihood that the doctors would report positive results from robotic surgeries. Despite those concerns, the business -- like the stock -- has grown steadily.
Has the business kept pace with the stock?
Intuitive Surgical generates its $4.4 billion in annual revenues by selling its da Vinci surgical systems, which average $1.5 million each, as well as their yearly six-figure service contracts and the disposable instruments and accessories that are needed to use the systems, which run $2,000 per procedure. With a market capitalization that has grown 26,500% since its IPO, it might be hard to believe that the business fundamentals had kept up with the stock price. That said, the company's annual revenues are up by more than 16,000% since its IPO, and its gross profit has climbed 33,000%.
In the past few years, the valuation of the company has increased significantly. While the stock generally used to trade at a price-to-earnings (P/E) ratio in the neighborhood of 40, it's now trading around 85 times earnings. Many might be tempted to chalk that increase up to the current frothy market conditions -- many stocks seem to be hitting new all-time highs each week. However, the change in that metric makes more sense when one considers how each da Vinci sale acts like a planted seed, growing into a source of recurring sales and profit for years to come.
Adding the revenue from the company's annual service contracts plus the instruments and accessories, and dividing by the previous year's installed base of surgical systems, we can calculate roughly how much recurring revenue each machine is generating annually. The result might explain why investors are willing to pay so much more for the shares today than they were in years past.
| Metric | 2020 | 2019 | 2018 |
|---|---|---|---|
| Instrument and accessory revenue | $2.46 billion | $2.41 billion | $1.96 billion |
| Service revenue | $724 million | $724 million | $635 million |
| Previous year installed base | 5,582 | 4,986 | 4,409 |
| Recurring revenue per system | $570,000 | $628,000 | $589,000 |
Data Source: Intuitive Surgical. Author's calculations
It appears every surgical system sold creates an annual revenue stream of about $600,000. With nearly 6,000 surgical systems in use, that's about $3.6 billion per year. If you wanted to earn that from 10-year U.S. Treasury bonds, you would have to invest about $276 billion in them. From that perspective, the company's market capitalization of $87 billion doesn't seem expensive at all. However, unlike bondholders, shareholders will have to endure stock price volatility to realize those returns.
A long road of growth ahead
Intuitive Surgical has come a long way since its IPO in 2000. It has grown from 116 employees to more than 8,000, and advanced from performing a few thousand general laparoscopic surgeries annually to more than 1.2 million procedures each year -- spanning gynecological and urological surgeries, hernia repair, as well as bariatric and colon surgeries. As the number of procedures the da Vinci system is capable of performing continues to increase, existing machines will be utilized even more, driving further consumption of the instruments and accessories. Although the company has dealt with questions over the safety and efficacy of its surgical systems over the years, the number of approved procedures has continued to expand both in the U.S. and internationally.
Mathematically, it won't be possible for new shareholders to realize the types of gains generated since Intuitive Surgical's IPO. However, with the percentage of revenue from recurring sources growing with each da Vinci system sale, the future of the company is more predictable than it has ever been. Despite its seemingly stretched valuation, the company's prospects for reliable revenue growth should support further increases in the stock price.
