Is This High-Growth Healthcare Stock in Trouble?

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On Tuesday, Mar. 5, the Dow Jones Industrial Average set a new all-time high. The average broke through its previous record from October 2007 on broad economic optimism. One stock that sat out the day’s rally and has exhibited poor stock performance recently is Intuitive Surgical (NASDAQ: ISRG). An inquiry from the Food and Drug Administration as well as worrisome death reports have sent investors rushing for the exits. Intuitive Surgical has been a market darling for years, providing huge growth in sales and profits, along with even more impressive share price performance. Would investors be well-advised to join the chorus of worries and dump the stock? Or is riding out the storm a better strategy?

When the FDA comes calling

Shares of Intuitive Surgical have more than doubled since the beginning of 2011 on the strength of superb operating performance over the past several years. The company’s total revenue has climbed more than 27% annually since 2009. Meanwhile, diluted earnings per share soared almost 40% annually over the same time period.

Unfortunately, it’s well understood that healthcare companies operate under a different and more highly scrutinized risk profile. Companies such as Intuitive Surgical expose themselves to significant litigation risk. When the FDA begins an inquiry into the safety of a healthcare company’s product, it’s rarely good news for that company’s stock. That’s exactly what happened when in January, the FDA surveyed surgeons about the potential complications resulting from procedures performed by Intuitive Surgical’s da Vinci robots.

Fellow robotic surgical company MAKO Surgical (NASDAQ: MAKO) competes with Intuitive Surgical and could be an alternative, but unfortunately MAKO has its own set of problems. A year ago this time, MAKO reached $45 per share. A myriad of problems resulted in MAKO’s shares cascading downward, to its current level of roughly $12 per share. To the company’s credit, total revenue more than doubled since 2010, to more than $102 million. Unfortunately, the continuing lack of profitability is an ongoing concern for MAKO. The company has reported a net loss for three consecutive years. In the company’s most recent annual report, MAKO lost more than $32 million.

Investors not interested in the wild swings that the surgical robot makers have exhibited in recent years may be better served considering a more stable large-cap healthcare stock such as Johnson & Johnson (NYSE: JNJ). The company operates a medical device segment, but also holds several well-known consumer brands including Listerine and Band-Aids that provides investors a rock-solid business. JNJ trades for a more attractive price-to-earnings ratio than Intuitive Surgical of 20 times and pays a 3% dividend to shareholders. Johnson & Johnson is a fortress that can offer you less volatility than Intuitive Surgical. J&J holds a market value in excess of $215 billion and has raised its dividend for 50 years in a row.

Where to go from here

As recently as late February, Intuitive Surgical traded for more than 36 times its trailing twelve-month diluted earnings per share. High expectations were baked into the stock price, and a potentially damaging inquiry from the FDA was the catalyst needed to bring the stock’s momentum to a grinding halt. On a day in which the broader equity markets rallied 1% and the Dow Jones Industrial Average set a new high, Intuitive Surgical fell another 3% to its recent level of $525 per share.

That being said, Intuitive Surgical is still trading above where it entered 2013 and well above where it was to begin 2012. It remains to be seen whether the FDA inquiry will result in anything meaningful. It’s entirely possible that the market is overacting to what are still preliminary reports. The company maintains its robots are extremely safe.

This could blow over, and if that were to occur, then the recent sell-off should be considered a nice buying opportunity. Unfortunately, no one has a crystal ball to foretell exactly how this will play out. Despite the recent hiccup, Intuitive Surgical is still trading for more than 30 times trailing diluted earnings per share. The stock trades for 10 times sales and more than 6 times book value. Intuitive Surgical, while a great growth story these past few years, carries a lofty valuation. While high-growth investors still probably prefer Intuitive Surgical’s enticing growth potential, more prudent investors may want to consider a more reliable healthcare stock like Johnson & Johnson that will help you sleep well at night. With regard to Intuitive Surgical, investors would be wise to take a cautious approach and consider waiting for a further pullback before committing capital to the stock.

Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends Intuitive Surgical, Johnson & Johnson, and MAKO Surgical . The Motley Fool owns shares of Intuitive Surgical and Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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