Even great companies can turn into poor investments if you buy them at the wrong time. That's why it is important to take a hard look at a company's valuation before pulling the trigger.
Continue Reading Below
Shares of Exact Sciences (NASDAQ: EXAS), Illumina (NASDAQ: ILMN), and Intuitive Surgical (NASDAQ: ISRG) have all gone on huge runs in 2017 and are currently trading at lofty valuations. Are their growth engines strong enough to keep the momentum going?
Colon cancer claims the lives of more than 50,000 American lives each year, which is a tragedy since this disease is highly treatable if caught early. Sadly, patient compliance to current standard-of-care screening methods is abysmally poor.
Exact Sciences created a product called Cologuard that hopes to fix this problem once and for all. Patients using Cologuard can get screened for colon cancer simply by sending the company a stool sample from the comfort of their own home.
While Cologuard got off to a rocky start, the recent results have been nothing short of fantastic. Exact Sciences has pumped out back-to-back earnings reports that feature triple-digit growth, lower-than-anticipated losses, and big guidance boosts. The results have put the hurt on short-sellers as shares are up 190% since the start of the year.
Continue Reading Below
On the flip side, the prosperity has propelled the company's valuation to more than 25 times sales, so the pressure has been amped up for the company to continue to perform. However, management believes that it has only captured about 2% of its current addressable market. That hints that there should be plenty of room left for explosive growth rates to continue.
Illumina has long been a market darling thanks to its complete dominance of the genetic testing equipment industry. The company has been rolling out cutting-edge sequencing machines that provide faster testing times and lower costs than previous models for nearly two decades now. This model has made it the go-to provider for researchers and scientists who want access to top-notch equipment. At the same time, Illumina's highly lucrative razor-and-blade business model, in which it profits not just from the sale of sequencers but also from the consumables used every time a gene sequence is performed, has translated into steady gains on the top and bottom lines.
Recently, Illumina upped its game once again by announcing the launch of its brand new NovaSeq series. This new product platform promise to drive down the costs of sequencing an entire genome to as low as $100. That's a low enough price point to drive mainstream adoption and promises to finally usher in the age of personalized medicine.
Of course, you could argue that all of this potential prosperity has already been baked into the company's valuation. Trading at more than 11 times sales and 50 times next year's earnings estimates, there's no doubt that Wall Street is pricing Illumina for fast growth. However, early signs show that the NovaSeq series is a big hit with customers that have never purchased a sequencing system before, which is a big reason why the company recently crushed its quarterly estimates and raised its full-year guidance. If Illumina can keep its business momentum going strong, then there is no reason to believe that its stock won't follow suit.
Intuitive Surgical is another perennial Wall Street favorite that has been on fire as of late. Shares of the robotic surgical pioneer have soared more than 54% since the start of the year thanks to faster-than-expected growth in procedure volumes worldwide. System sales are also chugging along thanks to the recent introduction of the da Vinci X, which is the company's new low-cost surgical system. Management believes that the X is going to be a hit with cost-conscious hospitals, which is great news since Intuitive also sports a razor-and-blades business model.
Meanwhile, Intuitive's management team continues to invest like crazy developing new products and procedures and expanding its geographic footprint. If history is any guide, those investments should pay off in spades down the road, especially when considering just how much the robotic surgery market is predicted to grow over the next few years.
Despite the potential, Wall Street believes that Intuitive's bottom line is only going to grow at 11% annually over the next few years. That could be perceived as a tepid growth rate for a company that is trading around 13 times sales and for 40 times forward earnings.
Nonetheless, investors should remember that Intuitive boasts a long history of meeting or exceeding expectations. With new products on the way and business momentum working in the company's favor, I like Intuitive's chances of continuing to outperform from here and will continue to hold my shares.
The price of admission
Wall Street often rewards companies that have bright futures ahead with lofty valuations. Given their growth potential, it isn't surprising to see that all three of these businesses have turned into market darlings. While it can be mentally difficult to buy into a company that trades at a premium, I'm personally bullish on all three of these companies over the long term. For that reason, I still think that it makes sense for interested investors to buy few shares of these growth stocks today.
10 stocks we like better than Illumina
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Illumina wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of August 1, 2017