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5 Top Medical Device Stocks to Buy Now

Keith Speights, The Motley Fool

An artificial valve helps ensure that blood flows properly through a grandmother's heart. A 10-year-old boy with diabetes is able to live a normal life with an insulin pump implanted in his body. A physician uses a robotic surgical system to obtain a tissue sample from a middle-aged coach's lungs to determine if he has cancer. All of these are examples of how medical devices are improving the quality of life and even saving lives for people around the world.

While medical devices are helping patients, they're also helping some investors. Medical device stocks overall have delivered more than twice the gains generated by the S&P 500 index over the last 10 years. Investors hoping to profit from the continued boom in medical device stocks have lots of alternatives. But what are the top medical device stocks to buy now? Here's what you need to know. 

A hospital room with bed and medical devices.

Image source: Getty Images.

What is the medical device industry?

When you think of medical devices, you might picture machines that beep in hospital rooms. While those machines certainly are medical devices, there are many other kinds of medical devices as well.

The U.S. Food and Drug Administration (FDA) is a federal agency responsible for protecting the American public by overseeing the safety of food, drugs, cosmetics, and medical devices. The FDA defines a medical device broadly, stating that a medical device is any "instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or other similar or related article...intended for use in the diagnosis of disease or other conditions, or in the cure, mitigation, treatment, or prevention of disease, in man or other animals." In addition, a medical device can be intended to "affect the structure or any function of the body of man or other animals."

The bottom line is that medical devices can include a wide range of things, from surgical staples to artificial heart valves. As a result of the FDA's broad definition, the medical device industry is huge, with at least 32,000 medical device companies based in the U.S. and Europe alone.

Some of these medical device companies are large, with annual sales in the tens of billions of dollars. However, most medical device makers are small. Many of them aren't profitable. The stocks of unprofitable companies are generally riskier for investors because a business can't survive indefinitely without making money.

Regardless of their size, medical device companies operate in a highly regulated industry. In the U.S., the FDA oversees which medical devices are allowed to be marketed. The FDA requires all medical devices to at minimum be registered with it. Medical devices that present a moderate risk to patients must undergo a more detailed review. Devices that pose a high risk to patients must first be tested in clinical studies to demonstrate safety and effectiveness. The FDA determines the risk level based on the potential negative consequences to patients' health of the given medical device.

Medical devices have existed for thousands of years. Archaeologists have even found evidence that prehistoric dentists used drills made from flint heads. Today, medical devices account for as much as 6% of total U.S. spending on healthcare. Market researcher EvaluateMedTech projects that the global medical device market will increase in size from $405 billion in 2017 to nearly $595 billion by 2024.

As mentioned earlier, medical device stocks, in general, have more than doubled the return of the S&P 500 over the last 10 years. They have also outperformed stocks in the broader healthcare industry by close to 90% during the same period.

Characteristics of top medical device stocks

There are three primary characteristics that differentiate top medical device stocks from others in the industry. Top medical device stocks:

1. Focus on medical devices using advanced technology

Many companies focus on relatively simple medical devices. However, these types of products tend to be more commoditized -- meaning they are largely interchangeable with devices made by another company. As a result of this commoditization, lower-tech medical devices primarily compete on price and don't provide high profit margins (the amount of money left over after paying all the costs of running the business) to the manufacturers. On the other hand, companies that focus on medical devices that use advanced technology typically have higher profit margins.

2. Have a significant opportunity for growth

Top medical device stocks also have a significant opportunity for growth. In some cases, companies offer new products that can capture market share away from established products. Other medical device makers introduce new products that meet an unmet need. There are also other companies with medical devices that have been on the market for a while but have opportunities to expand into additional geographic markets, expand the conditions for which the devices are approved, and/or increase revenue by obtaining higher reimbursement from payers.

3. Enjoy one or more key competitive advantages

Just having a significant opportunity for growth isn't enough, though. A company must enjoy one or more key competitive advantages, or moats, that enable it to capitalize on its growth opportunity. These competitive advantages can include offering products that are more cost effective than others or that offer more benefits than other products. Some medical device makers also claim competitive advantages from their status in the industry and their large customer bases.

Top medical device stocks to buy now

Each of the top medical device stocks to buy now focuses on medical devices leveraging advanced technology, having significant growth opportunities, and enjoying key competitive advantages over rivals. The top five medical device stocks to buy now are:

Company

Market Cap 

Key Products

Abiomed (NASDAQ: ABMD) $12 billion Heart pumps
Align Technology (NASDAQ: ALGN) $22.2 billion Clear orthodontic aligners, intraoral scanners
DexCom (NASDAQ: DXCM) $14.2 billion Continuous glucose monitoring (CGM) systems
Intuitive Surgical (NASDAQ: ISRG) $62 billion Robotic surgical systems
ShockWave Medical (NASDAQ: SWAV) $1.4 billion Intravascular lithotripsy devices

Data source: Yahoo! Finance, company regulatory filings. Market caps as of July 22, 2019.

1. Abiomed

Abiomed makes heart pumps for heart failure patients to temporarily assist the pumping function of the heart, allowing the heart to heal and recover from heart surgery. The company's Impella family of heart pumps includes several products, the first of which won FDA approval in 2015.

Abiomed's heart pumps incorporate advanced technology. Each type of Impella heart pump includes integrated motors and sensors. As an example of the complexity involved in these heart pumps, the company's Impella 2.5 heart pump is inserted through the femoral artery in the thigh to reach the left ventricle of the heart. It then draws blood out of the ventricle and delivers it to the circulatory system.

Abiomed estimates its addressable market in the U.S. alone is around $6 billion annually. The company has only penetrated 11% of this market, but it expects to capture 100% of the market over time. Outside of the U.S., Abiomed claims 17% penetration in the German market and 1% in the Japanese market. The company is also exploring other cardiovascular conditions for which Impella could be used, including myocarditis, peripartum cardiomyopathy, postpartum cardiomyopathy, and spontaneous coronary artery dissection.

The company's Impella heart pumps have been used to treat more than 100,000 patients across the world. Other companies are developing heart-assist devices but haven't progressed enough to secure regulatory approval yet. Abiomed's head start in the heart recovery market gives it a strong competitive advantage.

2. Align Technology

Align Technology is best known for its Invisalign clear orthodontic aligners used to straighten teeth. The company also markets the iTero line of intraoral scanners. While clear aligners made from plastic might not seem like very advanced technology, the process Align uses to make the aligners is certainly advanced.

Dental professionals use the company's intraoral scanners to create a 3D model of a patient's teeth. This 3D model is sent electronically to Align, where its technicians create a treatment plan for multiple iterations of Invisalign aligners.  The treatment plan is sent back electronically to the dentist or orthodontist for review. Once the treatment plan is reviewed, Align's manufacturing facility uses the plan to make custom clear aligners for the patient.

Align claims 16% of the 8 million orthodontic cases per year for which Invisalign is applicable. The company's market share of the large teen market is only 6.7%. As Align aggressively markets Invisalign, it should be able to significantly increase its share of the market. The company should also be able to expand its addressable market by introducing new versions of Invisalign that can treat more difficult cases of misaligned teeth.

New competitors including SmileDirectClub have emerged to challenge Align Technology, which for years had the clear aligner market all to itself. However, the company's network of dental professionals gives it a competitive advantage over rivals seeking to sell direct to consumers. The company's first-mover advantage and marketing efforts also have made more patients aware of the Invisalign brand than of other clear aligner brands.

3. DexCom

DexCom specializes in developing and marketing continuous glucose monitoring (CGM) systems, which continually monitor glucose levels in patients with diabetes. DexCom's lead product is the G6 CGM. The G6 sensor is implanted under a patient's skin, often on the back of the arm. A transmitter connects to the sensor and sends real-time data on insulin levels to a receiver or smartphone. This information can also be shared with other people, for example with doctors or with parents of children using the device. The G6 CGM sensor can be worn up to 10 days before being replaced.

Unlike most glucose monitoring systems, DexCom's G6 doesn't require fingersticks. The system can alert individuals when glucose levels are too low or too high as well as send alerts to others (a nice feature for letting parents know when their diabetic child's glucose levels are out of whack). The G6 can also integrate with other devices, including insulin pumps, smart insulin pens, and insulin patch pumps. And it can improve the health of patients by continually monitoring glucose levels rather than requiring patients to remember to check their levels.

Fewer than 25% of intensive insulin users in the U.S. use CGM systems. DexCom has captured less than 20% of the total addressable market.  This core market gives DexCom significant growth potential. The company is also looking to expand its market by exploring ways to use CGM in diabetes screening and intermittent monitoring (scheduled monitoring at specified intervals as opposed to continuous monitoring) for pregnant women, hospital patients, and patients with type 2 diabetes who aren't intensive insulin users, as well as diabetes screening for prediabetes patients. DexCom also has opportunities to expand more internationally. The company currently makes a little over 20% of its total revenue in international markets, but there are roughly 13 times more individuals with diabetes in other countries than there are in the U.S.

The extensive functionality and convenience of the G6 give it advantages over competitors. DexCom executives stated in May that the new G7 CGM system should launch in late 2020 or early 2021. The G7 should build on DexCom's competitive advantages through its smaller size, extended sensor wear, and lower cost.

4. Intuitive Surgical

Intuitive Surgical pioneered the use of robotic surgical systems with its 1999 launch of the da Vinci system. More than 6 million surgical procedures have been performed using da Vinci since then, with more than 5,100 systems implemented across the world.

To use the da Vinci, a surgeon sits at a console a few feet away from the patient. The surgeon can view a 3D high-definition image of the region on the patient where surgery is to be performed. Intuitive's system enables the surgeon to manipulate surgical instruments on da Vinci's robotic arm, eliminating the potential impact of tremors that can occur in the surgeon's hands. The robotic surgical system is used in multiple types of procedures, especially hysterectomies and prostatectomies.

Intuitive Surgical should be able to grow in three ways. First, long-term demographic trends are increasing demand for the types of surgical procedures for which da Vinci is most used. Second, the company continues to expand the types of surgical procedures that its technology supports. (For example, Intuitive launched its ION robotic system for lung biopsy in 2019.) Third, Intuitive plans to increase its international presence. More than 60% of its da Vinci systems are installed in the U.S., but there are many more surgical patients in the rest of the world.

The company's biggest competitive advantage is its big head start in the robotic surgery market. Intuitive's existing customers who purchased its systems have a financial incentive to maximize their return on investment. The company's growing number of customers that use alternative financing arrangements such as operating leases and usage-based agreements don't have to worry about buying new systems (their deals allow them to upgrade to newer models), which reduces the chance that they'll switch to a rival. In addition, Intuitive's long track record gives existing and new customers a solid reason to choose its systems. Also, as doctors become familiar with the system, they're likely to want to continue using da Vinci on more procedures rather than switch to another system.

5. ShockWave Medical

ShockWave Medical focuses on unclogging arteries by developing intravascular lithotripsy (IVL) technology for the treatment of calcified plaque in patients with peripheral vascular, coronary vascular, and heart valve disease. Its first IVL systems were approved in 2018 by U.S. and European regulators.

Lithotripsy has been used for more than 30 years in breaking up kidney stones. ShockWave's systems integrate lithotripsy into a device that resembles a balloon catheter. Physicians can guide the catheter through artery walls and send shock waves into the arteries to break up calcium deposits, clearing the blood flow through the artery.

ShockWave Medical thinks that its total addressable market is more than $6 billion per year. This market includes using IVL in procedures for clearing calcium in coronary arteries, aortic valves, common femoral arteries, and iliac arteries.

The company's main competitive advantage is that it is the pioneer of IVL technology and holds patents on this technology. IVL offers several benefits over traditional methods of unclogging arteries. The approach is safer, enabling physicians to treat even complicated cases with very few complications. It's simple: Physicians don't have much of a learning curve. IVL is also highly effective, cracking both superficial and deep calcium.

Risks for these medical device stocks

Although each of these medical device stocks has competitive advantages, the possibility that rivals could take away their market share is always a key risk. Most of the five top medical device stocks already face competition. And the medical device industry changes quickly. A competitor could launch new medical devices that are more cost effective or that offer more attractive capabilities.

Align Technology faces more direct competition than it has in the past. Intuitive Surgical once enjoyed a monopoly in the robotic surgical systems market but now has a handful of competitors. DexCom directly competes in the CGM market with one of the biggest medical device makers in the world, Abbott Laboratories. Both Abiomed and ShockWave could face increased competition in the future.

All five companies also face regulatory risks. New medical devices might not win the necessary regulatory approvals. A delay in securing FDA approval for a new medical device could seriously impact a company's growth prospects. Even after a device is approved, the FDA could identify potential safety issues that cause problems for the companies. And because medical devices have a lower bar for entering the market than prescription drugs do, the potential for issues being identified after launching the device is higher. This can lead to product recalls in which the medical device makers must ask patients to return the devices.

Abiomed experienced this kind of issue in February 2019 after the FDA issued a letter to healthcare providers about the Impella RP heart pump. The letter was misinterpreted by some as indicating that the heart pump was being recalled or had safety issues that were being reviewed by the FDA.

Each of these companies is at risk of product liability litigation. Patients could allege that a medical device caused physical problems or was defective. Such litigation can be costly to medical device makers and potentially cause negative publicity that makes it harder to attract new customers.

The companies could also come under attack from rivals that want to have their key patents revoked. For example, ShockWave Medical's key IVL patents have been challenged by a competitor, Cardiovascular Systems. The company thinks that its overall patent portfolio provides "multiple layers of defense," but this illustrates a real threat for any of these medical device makers.

Like stocks in most industries, these medical device stocks could also be dragged down by macroeconomic issues such as a recession. It should be noted, though, that medical device stocks tend to be more recession proof than many other stocks, because individuals need healthcare even in bad economic times. The stocks of companies that hope to grow in international markets could be hurt by the possibility of increased trade tensions. In addition, the potential for the implementation of a single-payer system in the U.S. could cause these stocks to fall as investors worry about limitations to the companies' ability to price their medical devices.

DexCom and ShockWave Medical also face one risk that the others don't: The potential need to raise cash. Unlike Abiomed, Align Technology, and Intuitive Surgical, DexCom and ShockWave aren't profitable yet. It's possible that they could need to raise additional capital by either taking on debt or issuing new shares. Higher debt levels increase interest expenses and reduce the amount of money available to invest in expansion. Issuing new shares causes shareholder dilution -- the value of existing shares decreases because more shares become available for trading.

Looking ahead

These risks show there's no guarantee of success for any of these five top medical device stocks. However, the overall prospects for the stocks still appear to be quite good. Abiomed, Align Technology, DexCom, Intuitive Surgical, and ShockWave Medical should provide plenty of excitement for growth-seeking long-term investors.

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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 recommends ShockWave Medical. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com