How can you benefit from rising healthcare costs?
Just about everyone knows that healthcare costs have skyrocketed over the past quarter-century. One less-appreciated corollary is that shareholders of companies in the industry have been very richly rewarded. Today, we're going to investigate two such companies to see which is the better buy at today's prices.
Intuitive Surgical (ISRG +0.08%) is the company behind the daVinci robotic surgical system, which allows doctors more precision in minimally invasive procedures. Johnson & Johnson (JNJ 0.41%) is a different beast altogether, with divisions focusing on pharmaceuticals, consumer-facing products, and medical devices.
While there's no perfect comparison to determine which is the better buy, I'll be running these companies through three different lenses that I consider vital to any investment thesis to see which one I consider to be more suitable.
Financial fortitude
Debt makes things more fragile. Cash makes them much more robust. It's as simple as that.
If a company is in debt and falls on hard times, operations usually need to shrink, market share can be lost, and bankruptcy is even a possibility. On the flip side, a company with a lot of cash in the bank can pounce on such opportunities, outspending rivals to get market share, making strategic acquisitions, and even buying back company stock.
Here's how Intuitive and J&J stack up when it comes to financial fortitude.
|
|
Cash |
Debt |
Net Income |
Free Cash Flow |
|---|---|---|---|---|
|
Intuitive Surgical |
$1.6 B |
$0 |
$628 M |
$783 M |
|
Johnson & Johnson |
$38 B |
$20 B |
$15.4 B |
$15.8 B |
Source: Yahoo! Finance. Net income and FCF are presented on a trailing twelve month basis.
Both of these companies are in solid positions. While it might look like Intuitive Surgical is much weaker than J&J, it's worth noting that J&J's market cap is almost 13 times the value of Intuitive Surgical's. Once we take that into consideration, we can see that J&J has a slight edge in terms of both net income and FCF.
But I'm going to give the nod here to Inuitive Surgical. Why? Because it has absolutely zero long term debt, and has no problem pulling in free cash flow, giving it lots of options even if the company, or the entire healthcare industry, falls on hard times.
Winner = Intuitive Surgical
Valuation
There are lots of ways to measure the value of the stocks you are buying. When comparing two companies that are as different in size as these two, taking them all into consideration is important. Here are my four favorite metrics for this task.
|
|
P/E |
P/S |
P/FCF |
PEG Ratio |
|---|---|---|---|---|
|
Intuitive Surgical |
31 |
10.1 |
31 |
2.3 |
|
Johnson & Johnson |
18 |
4.5 |
20 |
3.1 |
Source: Yahoo! Finance, E*Trade. Non-GAAP earnings used to calculate P/E.
Intuitive Surgical is a faster growing company than the much more mature J&J. And neither of these stocks is particularly cheap.
That being said, while J&J might have a higher PEG ratio, I think it offers a better entry point right now than Intuitive Surgical. Not only does it have much lower multiples on virtually every front, but investors also need to consider that buying shares of the conglomerate will also get them a nice 2.7% dividend yield.
Winner = Johnson & Johnson
Sustainable competitive advantage
In my eight years as an investor, there's nothing that's been more important to the long-term success of my decisions than the sustainable competitive advantages of the underlying companies I'm purchasing. While no advantage is truly sustainable to infinity, some are better than others.
With Johnson & Johnson, there are three divisions to consider. The consumer-facing products -- like Band-Aids -- make up 20% of J&J's sales. These products benefit from the strength of their brands and give the company pricing power over generic alternatives.
The company's pharmaceutical division accounted for 45% of sales in 2015, led by sales of Remicade, Stelara, and Zytiga. All of these compounds are patent protected, which offers a level of protection, but those patents are limited. The company needs to rely on continually pumping R&D dollars to develop new drugs.
Patents also protect medical devices, which make up the other 35% of sales -- though in this case, the patents are somewhat longer lasting.
For Intuitive Surgical, the only competition for the longest time was simply traditional surgery. But now, pure play companies are entering the robotic surgery foray, as are larger, more entrenched players. That being said, Intuitive has huge advantages over the competition. Doctors have been trained in, and are using, the daVinci system for well over a decade. The installed base of machines -- combined with the collective knowledge of what they can do for patients -- is unmatched.
At the end of the day, I'd say that both companies have moderate-to-strong sustainable competitive advantages.
Winner = Tie
So there you have it, both companies are decent bets for your money today. While I own shares of Intuitive myself, that has more to do with my investing style than a disbelief in Johnson & Johnson. At the very least, investors with an interest in the healthcare sector would be well served to put both companies on their watch list.
