Taking the Pulse on Med Tech Stocks

As recently as the 1990's, medtech stocks were the darlings of growth stock managers.

Offering investors high single digit revenue and earnings growth rates, the medtech space became an almost automatic sector allocation for many growth managers.

Problem is, as economist Herbert Stein once famously observed, anything that can't go on forever won't.

The high rates of revenue and earnings growth that the medtech industry made the companies targets for government intervention over the past few years, particularly since Medicare and Medicaid were paying for a huge percentage of the procedures.

Hospitals, too, began to balk at the significant price increases the companies were imposing, particularly when the product changes were relatively minor.


Thus, in a group where high single digit revenue increases were not unusual - not to mention 40%+ profit margins - revenues for medtech companies have seen a marked slowdown in recent years.

The pace of revenue growth has slowed by as much as 75% from 10 years ago, particularly in the cardiovascular device market. Earnings have also been under pressure, although the group has done a reasonable job of slowing the rate of manufacturing costs to be in-line with revenues.

Medtech stocks have gone from trading at premium multiples to the market to either in-line with the market or at significant discounts, as investors have sensed that perhaps the days of being reliable growth stocks are largely in the past.

But that doesn't mean that you can't make money in the group, which is why I went over to Merrill Lynch's offices yesterday to hear Bob Hopkins speak.

Bob has been following the medtech space for years, and in my opinion is one of the best on the Street. 

Bob understands the science and mechanics of the products his companies sell as well as any analyst out there, and has demonstrated a good knack for picking winners among the group.  It also helps that Bob grew up with a father who was a practicing orthopedic surgeon in Buffalo.

Bob is more bullish on his stocks than you might expect.  He thinks that many of the investor concerns about earnings and growth are already largely reflected in today's prices.

Moreover, Bob thinks that the growth has a number of cost cutting opportunities that could sustain earnings for several years ahead.

Bob noted that managements of companies like Zimmer (ZMH) and Stryker (SYK) have both commented recently that the percentage of selling, general and administrative (SG&A) costs are far too high, and that significant cost cuts will need to be made in light of the slowing revenue trends.

Zimmer, for example, spends about 40% of its revenue on SG&A, but management believes it can reduce costs to 34% of revenue.

In addition, Bob thinks that many of the companies will be expanding their product offerings beyond what they currently produce. This will allow them to maintain at least a reasonable revenue growth rate regardless of any new government initiatives aimed at cost control.

Bob's favorites include Baxter (BAX); Strkyer and Zimmer. He also likes Intuitive Surgical (ISRG), which is a leader in surgical robotics.

In short, there may be more opportunity in the group than generally perceived.