The health-care industry has been hit hard by this year's market downturn -- somewhat surprising compared to past recessions. For pharmaceutical companies, the lower earnings multiples are understandable: Revenue is likely to drop off a cliff as patents expire.

But the medical device makers seem to be getting hit hard as well.

 

Average P/E 2005

Average P/E 2006

Average P/E 2007

Current P/E

Intuitive Surgical (NASDAQ:ISRG)

65

40

97

24

Boston Scientific (NYSE:BSX)

36

N/M

81

N/M

Stryker (NYSE:SYK)

28

29

32

14

Medtronic (NYSE:MDT)

37

23

20

28

Zimmer (NYSE:ZMH)

23

23

23

10

Source: Capital IQ, a division of Standard & Poor's. P/E = price/earnings excluding extras. N/M = not meaningful.

It would be understandable if those companies had seen a major downturn in earnings, but that isn't really the case; at least not with the most recent quarter.

 

YOY increase in TTM earnings,
ending Q3 2007

YOY increase in TTM earnings,
ending Q3 2008

Intuitive Surgical

22%

70%

Boston Scientific*

N/M

N/M

Stryker

33%

18%

Medtronic

2%

(20%)

Zimmer

(4%)

25%

Source: Capital IQ. YOY = year over year, TTM = trailing 12 months.
*Boston Scientific went from negative earnings in TTM Q3 2006, to positive earnings in the 2007 period, and back to negative in the 2008 period.

The bigger the equipment, the harder they fall
Most of the reduction in the multiples assigned to the companies is likely associated with the fear of earnings dropping in the future, as the credit crisis rocks its way through the economy. The big question is whether those expectations are realistic or fully overblown.

There's likely to be contraction in capital spending by hospitals, which affects major equipment makers such as Intuitive Surgical. Donations are down, endowments invested in the stock market are way down, and it's unlikely that capital spending in 2009 can or will stay at levels seen this year and last. Intuitive Surgical hasn't given guidance for next year, but I doubt it'll stay at the roughly-50% income growth it's guiding for this year. There's just no way that hospitals can keep increasing the level of spending for large equipment.

On the other hand, sales of smaller equipment and implantable devices covered by insurance should probably be OK.

People still get sick
The old adage may be tiresome, but it's still true: People get sick whether there's a recession or not. Surgeries that use medical devices are going to happen in good times and bad, and that's going to result in earnings from implantable devices, as well as the disposable items used in already installed equipment like Intuitive Surgical's daVinci robot.

Sure, some elective surgeries will be put on hold, but there will still be a lot of operations that aren't all that optional, like the implant of cardiovascular stents sold by the likes of Abbott Labs (NYSE:ABT), Johnson & Johnson (NYSE:JNJ), and Medtronic.

And it's possible that some elective surgeries will be moved up during the recession. People worried about losing their jobs, and their health insurance, might decide to have an operation while still covered. Moving up surgeries probably won't help much in the long term, but medical device companies could see a short-term boost from the phenomena.

Value investing, health-care style
Health care is usually an industry inhabited by high-growth investors, but Philip Durell, Ron Gross, and their Motley Fool Inside Value team must be drooling at all the easy pickings. It doesn't take a brain surgeon to know that the full value of medical device companies will eventually be restored.

The secret is really just being a long-term investor. The higher earnings multiples should return once investors are convinced that the earnings growth is still there. Investors will get a double bump: once for increased earnings and again for an increased trading multiple.

Mmmm, I love a good value in the morning.

Johnson & Johnson is a Motley Fool Income Investor selection. Intuitive Surgical is a Rule Breakers pick. The Fool owns shares of Stryker. Try any of our Foolish newsletters today, free for 30 days

Fool contributor Brian Orelli, Ph.D., ate exclusively from the value menus at fast-food joints for most of the 1990s. He doesn't own shares of any company mentioned in this article. The Fool has a disclosure policy.