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5 Top Medical Device Stocks for 2019

Keith Speights, The Motley Fool

You might look back at 2018 as a dismal year for stocks. After all, both the Dow Jones and S&P 500 indexes were down for the year. But for many medical device stocks, 2018 was a fantastic year, with at least a dozen medical device stocks racking up gains of more than 25%. 

There's no way to know whether medical device stocks will perform as well in 2019 as they did last year. However, there are still quite a few stocks that should be long-term winners and have a decent shot at delivering nice gains this year. Here's what you need to know about the top medical device stocks for 2019.

Medical devices in a hospital

Image source: Getty Images.

Overview of the medical device industry

The most important thing to understand about the medical device industry is probably its product diversity. The U.S. Food and Drug Administration (FDA) defines a medical device in broad terms. This definition includes any "instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or other similar or related article, including a component part, or accessory" that is used in diagnosing, curing, preventing, or treating a disease. 

With a definition that expansive in scope, you'd expect that there would be a lot of companies making medical devices. And you'd be right. There are around 5,500 medical device companies in the U.S. alone, making products that range from artificial joints to bedpans to robotic surgical systems.

Some of these medical device companies are large and very profitable. However, over 70% of these companies have fewer than 20 employees. Many of them are still in the development stage and have no consistent revenue.

The competitive dynamics for these companies vary greatly depending on the type of product they make. Simple medical devices such as surgical supplies tend to compete primarily on price and typically have low profit margins. On the other hand, medical devices that use advanced technology often have little competition, can be very expensive, and in turn generate high profit margins.

All medical devices in the U.S. are regulated by the FDA. The agency places a medical device into one of three classes:

Class Risk Level Example Products
Class I Low Bandages, surgical gloves

Class II

Moderate Infusion pumps, surgical drapes
Class III High Breast implants, heart valves

Data source: FDA.  

The regulatory hurdles that a medical device company must clear depends on the class its medical device is assigned to. Class I devices usually only require registering with the FDA, and there's no approval process. For a small number of Class I devices, though, a regulatory filing called a 510(k) notification must be submitted to the FDA. This filing shows the FDA that the medical device is at least as safe and effective as an already-approved product that didn't require more extensive approval.

It's the opposite scenario for Class II devices. Just a few get by through only registering with the FDA, while most require the filing of a 510(k) notification.

The regulatory process for Class III devices is more involved. Companies must submit a premarket approval (PMA) application to the FDA, with clinical data that shows the medical device is safe and effective. The FDA reviews these PMA applications closely, and sometimes enlists the help of outside experts in the review process. Class III medical devices can only be marketed after receiving FDA approval.  

Growth prospects for the medical device industry

The medical device industry should benefit from aging demographic trends for years to come. An aging population translates to more cases of chronic disease and a greater demand for all types of medical devices. In addition, the emergence of larger middle classes in developing nations should increase opportunities for some segments within the medical device industry.

Overall, the global medical device market is projected to grow by a compound annual growth rate (CAGR) of 4.5% through 2023 to $409.5 billion, according to market researcher Lucintel.

However, medical devices that use advanced technology should grow even more. The global high-tech medical device market is projected to grow at a CAGR of 29.2% through 2026 to reach $252 billion, according to Research and Markets. This rapid growth is expected to be bolstered by emerging technologies such as the Internet of Things (IoT) -- the connection of all types of devices to the Internet for the purpose of collecting data, tracking usage, and automating systems.  

What to look for in medical device stocks

There are three primary things you should evaluate before buying a medical device stock:

  1. Financial position
  2. Competitive advantages
  3. Growth potential

The most important aspect of a medical device company's financial position to consider is its profitability. Many up-and-coming medical device makers don't yet have profitable operations. As a result, they must raise the capital needed to fund operations, typically through either borrowing money or by issuing new shares -- both of which can have negative consequences.

When a company takes on additional debt, its interest expenses increase. This reduces the amount of money available to spend in other areas like reinvesting in the business. Issuing new shares dilutes the value of existing shares. The company's total value doesn't change when more shares are issued, so dividing that value into more shares makes each share worth less.

Another key component of a medical device maker's financial position is its available cash, including cash equivalents and short-term investments. For companies that aren't yet profitable, the amount of cash available is directly related to how long it will be before additional capital must be raised through debt or issuing new shares. For profitable companies, the cash stockpile is important in providing flexibility for expanding through acquisitions or other business development deals.

Over the long term, competitive advantages will matter even more than a company's current financial position. When evaluating a medical device stock, research how its products compare to that of its competitors. The stocks of companies with medical devices that offer significantly more functionality than rivals or provide significant total cost advantages over rivals are more likely to be successful.

It's possible that a medical device company has a strong financial position and solid competitive advantages but weak growth potential. How? Some medical devices can have a small total addressable market or a market that is already saturated with little room for additional growth. Check out the potential markets for a medical device stock before buying to make sure that there's plenty of room for long-term growth.

Top medical device stocks for 2019

The top medical device stocks for 2019 illustrate the diversity of the medical device industry, with products as simple as clear plastic aligners for straightening teeth to robotic-assisted surgical systems. But these stocks have two key things in common. They all have solid competitive advantages. And they all have exceptional growth prospects.

Here are five top medical devices stocks to consider buying in 2019: 

Company Market Cap Key Products
Abiomed (NASDAQ: ABMD) $15.3 billion Heart pumps
Align Technology (NASDAQ: ALGN) $20.7 billion Clear dental aligners, intraoral scanners
DexCom (NASDAQ: DXCM) $12.4 billion Continuous glucose monitoring (CGM) systems
Intuitive Surgical (NASDAQ: ISRG) $62.7 billion Robotic surgical systems
Tandem Diabetes Care (NASDAQ: TNDM) $2.8 billion Insulin pumps

Data sources: Yahoo! Finance, company presentations.

1. Abiomed

Abiomed focuses on medical devices for treating cardiovascular diseases. Around 25,000 of its Impella heart pumps are implanted in patients annually. The company celebrated its 100,000th patient in the fourth quarter of 2018. 

Revenue has more than tripled since 2014. Abiomed boosted its full-year 2019 guidance, calling for a revenue increase this year of around 31%. And its earnings per share are growing even faster. All of this has put Abiomed in an enviable financial position. The company reported cash of around $450 million in its latest quarterly update and the company has zero debt.

Abiomed created the field of heart recovery using temporary heart pumps. The company really doesn't have a direct competitor in this market. That's the kind of competitive advantage that investors love. 

The growth prospects for Abiomed continue to look very good. Abiomed estimates that its current total addressable market in the U.S. is around $6 billion annually. It has only penetrated 11% of that market so far but expects to capture all of it. Outside of the U.S., Abiomed has penetrated 17% of the total addressable market in Germany and 1% in Japan. And these markets continue to grow as the country's populations age. 

2. Align Technology

Align Technology's flagship product is the Invisalign clear dental aligner. The company also sells iTero intraoral scanners that dental professionals use to create 3D images of patients' teeth, which are then used to development Invisalign treatment plans.

Strong revenue and earnings growth has been a common theme in Align's quarterly updates, although its earnings growth trajectory has slowed somewhat recently. The company continues to be highly profitable and has amassed a cash stockpile of $744.5 million, including cash, cash equivalents, and marketable securities.

Align pioneered the use of clear aligners for straightening teeth. The company continues to develop new products to treat more serious cases of malocclusion (misalignment of teeth). Align has also created a strong network of orthodontists and dentists who recommend Invisalign to their patients.

While some competitors have entered the clear aligner market, Align Technology isn't too worried about them. Actually, the company owns a significant stake in one of its top rivals in the direct-to-consumer market, SmileDirectClub.

Even though Align has been tremendously successful, there remains a huge untapped market. The company currently claims a market share of only 14% of the current addressable market. With new products on the way to treat more difficult cases, Align should be able to expand its addressable market significantly as well.

3. DexCom

DexCom focuses on developing and marketing continuous glucose monitoring (CGM) systems for individuals with diabetes. The company has been a leader in the CGM market for several years.

Sales have soared for DexCom, with an impressive CAGR of 44% from 2011 through 2018. The company reached profitability in 2018 and appears likely to keep the earnings flowing. DexCom also has plenty of cash on hand, reporting cash, cash equivalents, and marketable securities totaling nearly $1.4 billion as of Dec. 31, 2018.

DexCom's latest CGM system, the G6, enjoys several competitive advantages over rival products. G6 is the only system that meets all of the FDA's integrated CGM special controls for accuracy in determining glucose levels. It's the first CGM that doesn't not require any finger sticks -- a huge plus for patients with diabetes. The system also integrates with leading insulin pumps, smart insulin pens, and insulin patch pumps.

The market potential for DexCom is huge. DexCom has plenty of room to grow by focusing on its core patient population in the U.S. of 3.2 million individuals who require continuous glucose monitoring. However, there are an estimated 415 million people with diabetes worldwide. Only 6% of them achieve their desired outcomes, presenting a large potential opportunity for DexCom. 

The company also has an even more advanced product on the way -- the G7. This CGM system will be fully disposable and cost-effective for patients and payers. DexCom CEO Kevin Sayer said in the company's Q4 conference call that the G7 is on track to launch in late 2020 or early 2021. 

4. Intuitive Surgical

Intuitive Surgical pioneered the use of robotic surgical systems with its da Vinci system. More than 6 million procedures have been performed using the da Vinci, with around 1 million of those procedures occurring just last year. 

The company is in great financial shape. Intuitive's revenue jumped nearly 19% last year to $3.7 billion, while earnings soared 68% year over year to more than $1.1 billion. The company ended 2018 with a cash stockpile of $4.8 billion. 

Intuitive Surgical enjoys a couple of significant competitive advantages. First, it has a large base of customers who are motivated to maximize their return on investment with da Vinci rather than look for a new system. Second, the handful of companies with products that could potentially challenge Intuitive don't have the long track record that da Vinci has. CEO Gary Guthart noted in the company's Q4 earnings conference call that there have been nearly 1,500 peer-reviewed clinical journal articles for the da Vinci system.

But can Intuitive Surgical continue to generate strong growth? It seems likely. Many surgical procedures still have way too many complications resulting from differences in the skill of surgeons. Robotic surgical systems like da Vinci help reduce these issues. The long-term demographic trend of aging global populations also should increase the numbers of procedures performed in the types of surgeries for which da Vinci is most used.

Also, Intuitive Surgical is investing heavily in research and development. The company's latest system, ION, enables lung biopsy using minimally invasive robotic technology. Investors can expect more advances from Intuitive in the future. 

5. Tandem Diabetes Care

Like DexCom, Tandem Diabetes Care focuses squarely on the diabetes market. Instead of CGM systems, though, Tandem develops and sells insulin pumps.

Tandem's sales have been growing at a phenomenal rate, jumping 71% in 2018. And the company posted a profit for the first time in the fourth quarter of 2018. As of Dec. 31, 2018, Tandem had cash, cash equivalents, and short-term investments of $129 million. 

While there are other insulin pumps on the market, Tandem's newest product, the t:slim X2, has several competitive advantages. For one thing, it integrates with DexCom's G6 CGM system. It also is the smallest insulin pump on the market, which makes it more convenient for users to wear. Also, the pump's Basal-IQ technology helps predict when insulin levels are about to move outside of thresholds before they do. 

Tandem has a big growth opportunity in the U.S. The company thinks that it will be able to increase the number of Americans with diabetes who use insulin pumps from around 550,000 to 900,000. Tandem also is targeting another 3 million people with type 1 diabetes who live outside the U.S. 

Risks

The greatest risk for these medical device stocks is the threat of competition. The medical device industry is constantly changing, with new and improved technology regularly introduced.

Align Technology and Intuitive Surgical enjoyed virtual monopolies for several years, but now both companies face new rivals. The other companies are also likely to see stiffer competition in the future.

Several of the companies also could be hurt if global trade issues aren't resolved. In particular, U.S.-China trade tensions could present challenges for medical device companies that either already have a presence in China or hope to establish operations there.

There's also a risk that new products in development could fail to secure FDA approval or encounter delays in receiving clearance for marketing, as well as the risk for product liability lawsuits and legal action if any of the medical devices turn out to be less safe than once thought.

Looking ahead

Despite these risks, the future appears to be bright for the medical device industry -- and particularly for companies with high-tech medical devices. Abiomed, Align Technology, DexCom, Intuitive Surgical, and Tandem Diabetes Care should be in great shape to succeed in 2019 and beyond. 

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Keith Speights owns shares of Align Technology and Intuitive Surgical. The Motley Fool owns shares of and recommends Abiomed, Align Technology, and Intuitive Surgical. The Motley Fool has a disclosure policy.