Another week, another all-time high for Intuitive Surgical (NASDAQ: ISRG).
Shares of the robotic surgical systems maker are up more than 60% so far in 2017. For much of the year, Intuitive Surgical has repeatedly broken its previous record levels as the stock has relentlessly moved higher and higher. The lackluster years of 2013 through 2015 have given way to seemingly nothing but blue skies for the company.
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But can Intuitive Surgical's momentum continue much longer? Is the stock still a buy after its huge run-up? Here's what you need to know.
A solid business with solid growth potential
There's one word that jumps out when you look at Intuitive Surgical's business: solid. The company's revenue increased nearly 18% year over year on the first half of 2017. Earnings soared almost 25% compared to the prior-year period. Intuitive Surgical has generated $871 million in free cash flow over the last 12 months.
What's really impressive about Intuitive Surgical's business is that its continued success doesn't depend primarily on selling new systems. In 2016, 71% of the company's total revenue stemmed from recurring sources like instruments, accessories, and service contracts. That figure increased to 74% in the first half of this year.
Intuitive Surgical's business model is a high-tech version of the old razor-and-blades model. The company sells its da Vinci robotic surgical systems for a hefty price, but the big money is made from selling replacement instruments and accessories on a regular basis to customers.
But will Intuitive Surgical's business remain solid? It seems highly probable. There are two dynamics investors should consider. First is the potential for market growth. Second is the potential for competition. The former dynamic helps make Intuitive's business even more solid, while the latter could weaken its business.
The prospects for future market growth appear to be strong. In the U.S. alone (Intuitive Surgical's top market), nearly 5.5 million procedures are performed annually for the top 15 surgical procedures. Intuitive's da Vinci system is used for for less than 600,000 of those procedures. Significant opportunity remains for the company to expand into new procedure types.
There's also a huge untapped international market. Nearly two-thirds of da Vinci systems are installed in the U.S., but almost 96% of the world's population lives outside of the U.S.
On the other hand, Intuitive Surgical's near-monopoly could be in jeopardy. Medtronic (NYSE: MDT) plans to roll out its robotic surgical system in 2018. The medical-device company could be a formidable competitor against Intuitive Surgical. Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) and Johnson & Johnson (NYSE: JNJ) teamed up to create a joint venture company, Verb Surgical, that is also developing robotic surgical systems. Verb Surgical expects to launch its product as early as 2020. And if Intuitive Surgical expands into new procedure types, it could encounter more competition from rivals with products already on the market.
What about valuation?
While Intuitive Surgical truly has a solid business, there's another factor that investors need to think about before buying the stock: valuation. It's wise to remember what Warren Buffett once said: "For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments."
Is Intuitive Surgical stock too high? The traditional valuation metrics would indicate that's the case. Shares currently trade at nearly 52 times trailing-12-month earnings and at almost 37 times expected earnings. Wall Street projects average annual earnings growth for Intuitive Surgical of around 11%, which gives the stock a price-to-earnings growth (PEG) ratio of 3.72. These all reflect lofty valuations.
However, for much of 2004 through 2007, Intuitive Surgical's valuation was higher than it is now -- and the stock performed quite well. A high valuation doesn't necessarily mean the stock won't rise. However, there's an old saying that is applicable: priced for perfection. To justify its current valuation, everything needs to go perfectly (or pretty close to it) for Intuitive Surgical. Any slip-ups, and the stock could plunge.
Still a buy?
I really like Intuitive Surgical's business, its business model, and its growth prospects. The potential threat of competition doesn't concern me too much -- at least not yet. Intuitive Surgical has a big head start in its core procedure types. There's also a large cost for existing customers to switch to another system, so Intuitive's recurring revenue should keep on flowing.
That high valuation does give me some concerns. Ideally, Intuitive Surgical stock would be a little less frothy before buying. However, the market doesn't always give ideal scenarios. My instinct says Intuitive Surgical stock should still be a winner for investors over the next several years, in spite of the fact that it's trading at nose-bleed levels. My take is that the robotic surgical systems stock is still a buy. I don't think the current all-time high record will last for long.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Keith Speights owns shares of Alphabet (A shares). The Motley Fool owns shares of and recommends Alphabet (A and C shares), Intuitive Surgical, and Johnson & Johnson. The Motley Fool owns shares of Medtronic. The Motley Fool has a disclosure policy.