Better Buy: Illumina, Inc. vs. Roche Holding Ltd. (ADR)

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Few industries have experienced the kind of growth over the past two decades to match healthcare. As technologies expand our lifetimes, healthcare companies have serious incentives to continue developing breakthrough medicines and technologies that make those breakthroughs possible.

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Two such companies are Roche (NASDAQOTH: RHHBY) and Illumina (NASDAQ: ILMN). The former is a giant Swiss drugmaker that focuses on cancer treatments, while the latter has developed the leading gene-sequencing instrument.

But between these two, which is the better stock to buy today? That's not a question that can be answered with 100% certainty. By evaluating the two companies on three different facets, though, we can get a better idea for what we're buying at today's prices.

Sustainable competitive advantages

For long-term, buy-to-hold investors, there's nothing more important to evaluate than a company's sustainable competitive advantages -- often referred to as a "moat." At its core, a moat is what makes you different from your competitors. It's what keeps customers coming back year after year, while keeping the competition at bay.

In the medical field, truly sustainable moats are tough to come by. The most common comes in the form of patents. But patents have a huge Achilles' heel: They have a short life span. That means if you don't come out with another blockbuster drug every few years, your sales can shrink overnight.

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Patents provide the primary moat for Roche. Last year, three cancer drugs -- Avastin, Herceptin, and Rituxan -- accounted for around 50% of all sales. It's great to have such important drugs on your roster, and Roche obviously has other drugs in its pipeline, but that's still a tenuous situation.

Illumina, on the other hand, enjoys a moat provided by its installed base of sequencing machines. The barriers to entry to build a gene sequencer aren't insurmountable, but once a hospital buys one, it's not likely to change until the next product cycle comes along.

There are nearly 10,000 installed sequencers on Illumina's roster. Since the consumables that hospitals and diagnostic centers order are high margin, this creates a very reliable and growing stream of revenue.

For that reason, I'm giving the edge here to Illumina.

Winner: Illumina.

Financial fortitude

As investors, we all love to see cash either being paid back to us in the form of dividends or reinvested into huge growth opportunities. But there's something to be said for a plain old pile of cash sitting around.

That's because at one point or another, every company will run into difficult financial times. Those that enter such times with lots of cash have options: Buy back shares, acquire the competition, or -- most critically -- outspend rivals into oblivion.

Those heavy in debt are in the opposite boat, forced to try to make ends meet at the expense of investing for future market share.

Keeping in mind that Roche is valued at over eight times the size of Illumina, here's how the two stack up.

Company

Cash

Debt

Net Income

Free Cash Flow

Illumina

$1.8 billion

$1.1 billion

$731 million

$466 million

Roche

$7.6 billion

$13.8 billion

$10 billion

$9.5 billion

When it comes to being financially nimble, Illumina is in the better position. With far more cash than debt, it has flexibility during tough times. Roche, on the other hand, is absolutely raking in the cash. But again, that cash is highly dependent upon the lifetime of key patents.

For that reason, Illumina wins this category as well.

Winner: Illumina. 

Valuation

Finally, we have the murky science of valuation. While there's no single metric that can tell you if a stock is cheap or expensive, there are a number of data points we can consult. Here are five that I like to use: price-to-earnings, price-to-free cash flow, PEG ratio, dividend, and free cash flow payout.

Company

P/E

P/FCF

PEG Ratio

Dividend

FCF Payout

Illumina

53

56

3.6

N/A

N/A

Roche

23

23

2.1

3.2%

65%

Here we have a very clear winner. Not only is Roche 50% cheaper on an earnings and cash flow basis, but it also offers a sustainable and hefty dividend to investors.

Winner: Roche.

My winner is...

So there you have it: Illumina is the better buy today. While Roche might have a more favorable valuation, Illumina's balance sheet and moat make it a more attractive investment today.

Investors who are looking to put money into the healthcare sector and want a moat wider than patents can provide should strongly consider a spot for Illumina in their own portfolios.

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Brian Stoffel has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Illumina. The Motley Fool has a disclosure policy.