In a speech to the Financial Planning Association, legendary Vanguard Founder and former CEO John Bogle made an observation that's absolutely critical to understanding where the best stock returns come from -- and how to find the next great stock to buy.
He told the assembled guests that only three things drive investor returns:
- Dividends
- Earnings growth
- Changes in valuation
That's all it comes down to. Historically, stocks have returned 9.6% per year on average -- 5%, 4.5%, and 0.1% from dividends, earnings growth, and valuation changes, respectively. Naturally, the best stocks to buy are the ones that will produce the highest combined return.
So which medical device stocks will earn investors the best returns today? Obviously, no one can say with total certainty. You should always take future estimates with a grain of salt, particularly when analyst forecasts are involved. In fact, studies show that analysts' long-term earnings per share estimates tend to be off by as much as 40%, so I've reduced their estimates accordingly.
But by running the numbers, we can compile a list of which stocks are the implied best buys today. Here are our assumptions:
|
Company |
Dividend Yield (current) |
5-Year Growth Rate (reduced by 40%) |
Assumed Price-to-Earnings Ratio (in 2016) |
|---|---|---|---|
|
NuVasive |
0% | 11% | 19 |
|
ZOLL Medical |
0% | 20% | 28 |
| Greatbatch | 0% | 9% | 18 |
| Cyberonics | 0% | 12% | 21 |
|
Covidien |
2% | 7% | 15 |
| Masimo | 0% | 12% | 21 |
|
Cantel Medical |
0.5% | 11% | 19 |
|
St. Jude Medical |
2.2% | 7% | 16 |
|
Hill-Rom Holdings |
1.4% | 9% | 18 |
|
Natus Medical |
0% | 9% | 18 |
Source: S&P Capital IQ. Includes stocks on major U.S. exchanges capitalized over $200 million, with positive earnings and at least one analyst issuing long-term earnings estimates.
And here are their implied five-year annualized returns for shareholders. I've ordered the three return components by their reliability -- first dividends, then earnings growth, then valuation.
|
Company |
Dividend Return* |
Earnings Growth Return |
Valuation Return |
Implied Cumulative Annual Return |
|---|---|---|---|---|
| NuVasive | 0% | 11% | 16% | 27% |
| ZOLL Medical | 0% | 20% | (1%) | 19% |
| Greatbatch | 0% | 9% | 8% | 17% |
| Cyberonics | 0% | 12% | 3% | 15% |
| Covidien | 2% | 7% | 4% | 13% |
| Masimo | 0% | 12% | 0% | 12% |
| Cantel Medical | 1% | 11% | 0% | 12% |
| St. Jude Medical | 2% | 7% | 2% | 12% |
| Hill-Rom Holdings | 2% | 9% | 0% | 11% |
| Natus Medical | 0% | 9% | 2% | 11% |
Source: Author's calculations. *Assumes dividend growth at rate of earnings growth.
The raw numbers tell us that these are the 10 most promising names among medical device stocks. Of course, analysts' growth assumptions for any individual company could prove overly optimistic or pessimistic, as could their future valuations, so the implied cumulative returns are hypothetical. That said, this list helps you focus on this sector's highest potential returners -- and provides an excellent starting point of names for further research.
So don't stop here. If any of these stocks interest you, add them to your personalized stock Watchlist. If you haven't started one yet, click here to begin.
