Medical equipment companies offer investors excellent long-term potential, especially if they can identify the prime companies to acquire. Several unique features make medical companies especially attractive, whether you are a growth or value investor. Of course, there are also risks.
Features of Medical Equipment Companies
Similar to pharmaceutical industry firms, medical equipment companies possess several characteristics that give them unique advantages over other companies.
The company that is first to the market with a new product, especially if it can obtain a patent, can win substantial market share. Patents are important to protect key design elements that make the product unique and deserving of a premium price. Companies that receive a premium price for their products generate higher margins, which in turn give investors a superior return on their money.
For some, medical equipment innovation is important in offering a competitive product. Many government authorities, such as the US Food and Drug Administration (FDA) recognize that they must adapt to the rapid innovation in medical products. Companies that can innovate quickly will benefit most, and so will investors who can identify these companies. To identify these companies, monitor their research and development activities, their filings with both health and financial regulatory authorities, and approvals from the regulators.
Many countries have an aging population. This demographic trend is a positive influence. Essentially, the rising tide of an aging population helps all the medical equipment companies grow.
Health insurance, including government assistance programs such as Medicare, covers the cost of many medical care products. Usually, the patient does not pay the full cost; many patients do not even know the cost of the products provided. On the other hand, these same agencies set the price they will pay for a product, which could limit the price received by the medical equipment company.
As a discretionary spending item, medical equipment purchases are not tied to the vagaries of the economic cycle. As a result, medical products companies are normally able to perform well during both the boom times and when the economy is slowing down. A large segment of the medical equipment industry also sells consumable items that are used each day by hospitals and medical professionals. Companies that manufacture these products tend to experience high levels of free cash flow. Since the use of these items is non-discretionary, the revenues tend to be steady despite the cycles of the economy. Moreover, with an aging population, the use of these items tends to grow faster than the overall economy.
What Type of Investor Are You?
Growth and value investors can find investing in medical equipment companies lucrative. Knowing the type of investor you are goes a long way to defining what to look for and when to invest.
In every industry, a healthy balance sheet is essential for growth, and the same applies to medical equipment companies. Companies that have sufficient cash or cash equivalents on hand to pay for their investments, such as research and development, have a much better chance of sustaining their growth. Preferably, they have minimal debt. If companies have debt, they can cover the cost of it from current operations. Moreover, the company should be generating profits and achieving positive free cash flow.
It helps if these companies have a strong culture of innovation. Innovation is vital to future growth, which benefits investors. Moreover, assess the company's research and development efforts and their filings with appropriate government agencies to evaluate the potential of new products in the pipeline.
The price to earnings (P/E) ratio is a popular tool used by investors to assess the promise of a company. For growth companies, look for a P/E ratio that is at or near the growth rate of the company's earnings. This is the PEG ratio, which compares the P/E ratio with the growth rate of the company's annual earnings per share. It's even more promising if you can find a company with an accelerating growth rate.
Value investors look for good businesses that earn more relative to the share price paid. In other words, the stock has fallen out of favor with Wall Street (for whatever reason), yet the company possesses good fundamentals. When you find such a company, look for reasons why it will grow its revenues and earnings more than is expected. Medical equipment companies that experience periodic dips in their share price might be good candidates. If the reasons for the share price dip are temporary, such as a lull between product cycles or temporary bad news, then this company could offer a good value.
In addition to stock market and sector risk, investors in the medical equipment sector should watch for particular product and company risks. While the use of debt can help a company grow, too much debt can consume cash generated from sales, reducing profitability. Medical equipment companies possess three main risks you will want to consider:
- A promising product may not prove to be as valuable as once thought.
- A product may not get approval from the regulatory authorities.
- A current product could become a liability should it cause harm to patients.
The Bottom Line
The medical equipment sector is well-positioned to take advantage of a growing demand for healthcare as the elderly become a larger percentage of the overall population. Moreover, innovations offer ways to improve the lives and welfare of everyone. The best time to buy depends on the type of investor you are. Growth investors can take advantage of the rapid innovation that many companies can accomplish, while value investors might find good buying opportunities on temporary dips in the price of a company's stock. In each case, investors should assess the long-term opportunities as well as the risk of the company and its products.