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Stocks  | February 19, 2020

When looking at the healthcare industry, one sector in particular has been booming: the medtech space. Over the past five years, this area of the market has outpaced the S&P 500, with the large-cap sector index achieving a CAGR of 13%-plus versus the index’s 11%-plus CAGR.

The source of this impressive growth? According to research from investment banking firm Goldman Sachs, the “durability” of this group of stocks fueled the strong performance. Highlighting organic sales growth, analyst Amit Hazan notes that from 2009 through 2015, a period that followed the 2008 recession and included 2015’s healthcare reform, “earnings growth for the group remained robust and never dropped below the high single digit-plus range.”

Looking forward, the Goldman Sachs analyst argues that “incremental contribution from a slew of new product innovations within robotics, cardiology, diabetes and other key subsectors and continued regional expansion into faster growing emerging markets” will drive 6%-plus top line organic growth in 2020 and 2021.

With this in mind, the analyst pointed to three medtech stocks as being especially compelling in a recent research report, kicking off his coverage of each with a Buy recommendation. Using TipRanks’ Stock Comparison tool, we were able to take a closer look at the picks by lining up the tickers alongside each other.

Intuitive Surgical Inc. (ISRG)

Earning a coveted spot on Goldman Sachs’ Conviction List, Intuitive Surgical has been at the forefront of robot-assisted surgery, with its da Vinci surgical system being one of the first robotic-assisted systems to receive FDA approval for general laparoscopic surgery. As of 2018, over six million surgeries had been performed using the technology all over the world. After posting a gain of 22% over the last six months, the firm believes that there’s more to come in 2020.

Weighing in on ISRG, Hazan points out that surgical robotics adaption is ramping up, and as a result, the total market is expected to triple by 2030. Additionally, while there could be a competitive impact from Medtronic and Johnson & Johnson, the four-star analyst thinks there will be a “greater benefit via market expansion than risk to ISRG’s share from competition.” This combined with new geographic drivers specifically in China should put growth at a steady 18%-plus.

Adding to the good news, Hazan expects annual growth contribution from new products to accelerate thanks to the release of its da Vinci Sp, Ion flex diagnostic platform, IRIS augmented reality and several new advanced stage instruments in 2020 and 2021. A new robotics system could also be unveiled within the coming 12 to 18 months.

Based on the above factors, earnings could get a significant boost. “A combination of solid top line growth, which slightly leverages OpEx, and a very strong balance sheet should result in consistent high teens earnings growth. Hence, our sales/EPS estimates come in well above the Street,” Hazan commented.

In line with his bullish take, the Goldman Sachs analyst initiated coverage by publishing a Buy rating along with a $725 price target. Should the target be met, a 12-month gain of 20% could be in the cards.

Like Hazan, other analysts like what they’re seeing. With 9 Buy ratings and a single Hold assigned in the last three months, the word on the Street is that ISRG is a Strong Buy. While less aggressive than Hazan’s forecast, the $668.67 average price target still implies upside potential of 11%.

Varian Medical Systems (VAR)

Using data and technology, Varian Medical Systems has helped advance radiotherapy, radiosurgery and many other vital cancer-fighting tools. While some investors have been concerned by its inconsistent quarterly performances, Hazan believes that its medium-term growth story is “healthier” than it has been.

The analyst expects the company to sustain oncology order growth in the high single digits or low double digits based on Ethos, Halcyon, HyperArc, several new software offerings and new EM opportunities in both China and India. As a result, Hazan tells investors that the company is in a stronger position than it was at any point during the last ten years. Additionally, VAR’s installed base growth has been gaining steam and it has been expanding its MSD. This in turn has enhanced its opportunities in terms of both software and service, with half of revenue now recurring.

On top of this, the company has been diversifying through new interventional oncology efforts. “While not very material quite yet, we expect this new segment to grow faster than the corporate average, be accretive to margins and earnings, and to diversify the Varian portfolio into new oncology channels and additional recurring revenue. We expect further investments into these markets, and believe it will be increasingly meaningful in the years ahead,” Hazan stated.

Despite the fact that operating margin swing has hampered the stock, Hazan points out that in the next few years, there could be a leverage opportunity. “As Halcyon ramps, oncology GM should improve, while service and software mix should also drive a benefit. The Proton margin drag should diminish as service sales ramp, while we expect recent M&A will increasingly be accretive each year,” he explained.

It should come as no surprise, then, that Hazan decided to side with the bulls, initiating coverage with a Buy rating. At $171, the price target implies shares could surge 16% in the next 12 months.

In general, the rest of the Street is on the same page. 5 Buys and 1 Hold coalesce into a Strong Buy consensus rating. Based on the $159.67 average price target, the upside potential comes in at 9%.

Stryker Corporation (SYK)

Thanks to its cutting-edge products and services in orthopedics, medical and surgical and neurotechnology and spine that help improve patient and hospital outcomes, Stryker has earned its reputation as one of the top medtech players. As the Goldman Sachs analyst is calling for another year of substantial top line growth, it’s no wonder investors are excited.

Based on Hazan’s estimates, organic growth could hit 8%-plus again in 2020. This is higher than Wall Street’s estimate as he thinks ortho robotic market growth and the contribution from new products within MedSurg and Neurotech appear somewhat under-modeled. He also sees less risk in store for SYK in the next year compared to other big growth companies.

While acknowledging that he’s somewhat concerned about a possible near-term disruption to the extremities sales force, Hazan still thinks organic growth in the orthopedic division will remain strong and that MAKO-driven share gains as well as a surgery day tailwind can fuel gains. “More broadly, we are bullish on the ortho robotic market for the next few years, with the US installed base reaching 3,500 by 2025 (a 20%-plus CAGR) and SYK maintaining a dominant share. In the medium-to-long term, we expect new robotic opportunities to help SYK’s hips, spine and extremities too,” he noted.

In addition, he pointed out, “Medical where strong capital trends and new products should help drive upside versus expectations. In Spine, growth improvement is very likely as K2M turns organic, but further integration risk as well as new competition from robotics suggest downside risk. Separately, Neurotech again looks poised for above-Street results as new Aspiration product intros take hold.”

This played into Hazan’s conclusion that a stronger valuation is on the horizon as investor confidence continues to improve. It follows, then, that the analyst started his coverage of SYK at a Buy and attached a price target of $248. This conveys his belief that SYK could rise 12% in the year ahead.

Looking at the analyst ratings breakdown, 7 Buys and 4 Holds add up to a Moderate Buy Street consensus. The $238.70 average price target puts the upside potential at 8%.

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