It's hard to argue with investing in blue chip stocks, as they tend to belong to established companies with relatively reliable earnings -- so much so that they typically pay dividends. Of course, there's good money to be made investing in smaller or less-proven companies on their way to becoming blue chips -- companies such as Intuitive Surgical, (ISRG -1.31%). Let's assess the company on several key traits of blue chip stocks and see how it fares:
Track record of performance over time
Intuitive Surgical has rewarded its long-term shareholders well, averaging an annual gain of nearly 34% during the past decade. It hasn't been the smoothest ride, though, as the average gain during the past five years was 14%.
The company is the global leader in its industry, with a market capitalization of more than $17 billion. One of its pure-play counterparts in robotic surgery, MAKO Surgical, was snapped up last year by Stryker Corporation for about $1.65 billion, giving you an idea of how big Intuitive is. You don't reach Intuitive's size without doing a lot of things right. The company's consistently growing top and bottom lines -- despite a recent blip -- bode well for its future.
Some blue chips achieve their size by disrupting the status quo. Intuitive fits this mold, facilitating a new way of operating on the human body via its da Vinci machines. Minimally invasive, they help surgeons operate through small incisions, guiding them via magnified 3D HD displays, and enhancing precision with small instruments more deft than human hands.
The daVinci system was the first robotic surgery machine system that was given the OK by the FDA for general laparoscopic operations. It's now also approved for cardiac, urologic, gynecologic, pediatric, and transoral otolaryngology procedures, as well as chest surgery.
Strong balance sheet, revenue growth and cash flow generation
Intuitive Surgical's balance sheet is solid, with little to no debt and an ample and growing pile of cash. The company's second quarter, reported in July, offered a lot to smile about. Both revenue and earnings beat estimates handily -- though the earnings growth got a boost from a hefty share-buyback plan. The quarter featured 10% more da Vinci units sold over the previous quarter, more than half of which were the new-and-improved da Vinci Xi machines. Also promising is that the number of procedures performed worldwide with da Vinci machines grew 9% year over year.
Interestingly, Intuitive's management started declining to offer projections early this year, due to uncertainty in the market, and uncertainty around how Obamacare will affect the industry. The Affordable Care Act actually does levy a 2.3% tax on medical devices. Intuitive Surgical has noted that it resulted in a 1% decline in gross profit in 2013, which is not likely to crush the company -- though it can make a bigger dent in the performance of smaller, less flush rivals, which is a plus for Intuitive.
A durable business model is critical for any would-be blue chip stock, and Intuitive Surgical qualifies there. It's poised to sell many expensive machines -- its da Vinci Xi has a price tag that ranges from about $1 million to more than $2 million, depending on options -- as more hospitals adopt the new technology; but it's not just dependent on machine sales. It derives much of its revenue from support of those machines, with consumable accessories and supplies, as well as with servicing. In its second quarter, recurring revenue was about three-quarters of total revenue, a most encouraging number.
Dividends are typically a feature of a blue chip company, and Intuitive Surgical doesn't pay any yet. Still, it generates more than $600 million in free cash flow annually, which helps it reinvest in itself and take advantage of opportunities that arise. Its share buyback plan is another way to reward shareholders, and the company has accelerated its $1 billion buyback plan.
Yea or nay?
Some dictionary definitions for the term "blue chip" are that the stock be of the highest quality and reliable. In other words, investments in blue chip stocks should help you sleep at night. Intuitive Surgical isn't there yet, as much uncertainty remains about how quickly and successfully it will grow. For example, despite our recovering economy, hospitals have not suddenly started snapping up da Vincis in droves. And questions are still being raised about how much more effective robotic surgery is than traditional surgery.
On balance, the company seems well worth considering for your portfolio, if you're comfortable with above-average risk. You might want to wait for a more compelling entry point, though, as the stock seems, at best, close to fairly valued, with its current P/E ratio a bit above its five-year average, and its forward P/E a bit below it.