IHI: Keep Riding The Medical Devices Momentum

Momentum traders have no doubt had the healthcare equipment sector on their radar, and maybe even for some time. While the healthcare and biotech sectors were posting losses in 2016, the medical devices sector bucked the trend with the iShares U.S. Medical Devices ETF (IHI) returning more than 9%. That trend has continued with the fund posting a 14% gain thus far in 2017 compared to a 7% return for healthcare and an 8% return for biotechs.

The group got another boost this past week when Intuitive Surgical (ISRG), the manufacturer of the da Vinci surgical systems that translate a surgeon’s hand movements to a robot that performs the actual procedure. The company reported a blowout first quarter that saw revenues jump 13%, earnings improve by 32% and shipments of da Vinci systems rise 21%.

The emergence of artificial intelligence and robotics within the healthcare industry is still at its nascent stages. It’s estimated that just 5% of surgical procedures performed are done with the assistance of some kind of robot technology. As the innovation of this technology expands and the general population continues to age, it’s easy to see how the medical device sector could be in the early stages of a long-term growth cycle. The global medical devices market is expected to hit $398 billion in 2017 and grow to over $520 billion by 2020.

And yet, despite the strong results coming out of the medical devices group, the sector is still pretty reasonably priced. As of this writing, the Medical Devices ETF trades at just 28 times forward earnings. That certainly won’t qualify the fund as a value play by any stretch and doesn’t compare to the 21-22 multiple of the broader healthcare and biotech sectors but for an area of the market that’s expected to grow as significantly as this one over the next few years, that valuation isn’t out of the ballpark. This fund may be the very definition of “growth at a reasonable price”.

The one thing that the fund isn’t, however, is diversified. While it has 51 holdings in its portfolio, the top 10 holdings account for nearly two-thirds of the fund’s assets. This includes healthcare giants Medtronic (MDT), Abbott Laboratories (ABT), Boston Scientific (BSX) and the aforementioned Intuitive Surgical. Given its concentration, seasoned investors who are more familiar with the medical devices space may wish to just buy select names instead of the fund as a whole. Investors looking for broader exposure to the sector will probably be better off buying the ETF.

Healthcare has been a long-term buy and hold sector for some time given the growing population and the aging of Americans. The use of robotics still has a limited number of applications in surgical procedures but the potential of companies manufacturing the technology that makes traditionally complex procedures minimally invasive is huge. Imagine a doctor performing a procedure on a patient in another country using this technology? There will likely be a lot of success and failure stories coming out of this group for a while but, for now, keep riding the momentum.

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