Intuitive Surgical, Inc. (NASDAQ:ISRG)

CAPS Rating: 4 out of 5

Intuitive Surgical makes and maintains the da Vinci robotic device, an advanced surgical system that lets surgeons perform minimally invasive surgery.


Player Avatar TheDumbMoney (43.71) Submitted: 10/1/2010 12:21:45 AM : Outperform Start Price: $286.51 ISRG Score: -10.66

Well, a new month, a new stock pick. I was torn this month. I considered MSFT, which I recently said I think is the most undervalued stock in my individual stock portfolio. But it already is one of the top five stocks in my portfolio, as a percentage of the total, and I do not want to add more at this time. I considered GSH, which S&P gives 5 stars to, and which the Fool has recently recommended. But it is a very capital-intensive industry, cash flow is inconsistent at best, returns on equity and invested capital are low, margins are low, there have been too-recent concerns about its accounting; I get the story, but I think if and when I buy a China-based stock, I can do better. I continue to put money into XOM every month in a DRIP account, and will continue to do so until, if not the end of time, at least until the stock price reaches about $70 or so, which it will, within the next year or so I think. I would frankly be relatively happy adding to many of the stocks I already own, in particular JNJ, BRK, UNH, INTC, and ABT, which are my other portfolio stocks that I think continue to trade at attractive values to initiate new purchases. Stocks like BDX, and WLP have been on my radar for awhile as well. Sometimes, the disembodied voice of TMFSincheruna speaks to me and tells me I should buy GLD: "just do it, do it! You KNOW gold's goin' to $2000! You an idiot if you question me! Gold is the only money! Fiat currency is a horrific innovation even though it has coincided with one of the most amazing productivity and living-standards booms of all time!" So far I have resisted the urge. Though I do see GLD going higher, I am not a currency trader, the macroeconomics are impossibly complex, there are no cash flows to value, and I am 100% certain I will hold on too long when it crashes and lose all of my gains and then some.

I have decided to take a different sort of risk, and to experiment with...(he shudders) a "growth" stock. Intuitive Surgical. This is also the first stock I have ever purchased in any way as a result of anything said on The Fool. It first came to my attention in an April or May article by a Fool writer. At the time I said, "cool!" looked at the P/E, promptly vomited, and put it my Watch List with a target price alert for if it ever got back down below $300/share. See more on that below, in value. So this is a departure for me in two respects, hence the overly-long pitch.

Story: Part A -- Macro: As my diligent readers (i.e., my mother and my dog) know from my UNH pitch, I believe the combination of demographic trends, bad habits, and bad incentives strongly favor growth in medical spending, regardless of our efforts to control it. This is true throughout the developing world. If I'm right, ISRG will benefit from this. Part B: Micro -- ISRG has an amazing product, is a first mover in the industry, has patent protection, and has a switching cost/sunk cost moat. Part C: Larger Picture -- I am coming to the conclusion that dividend stocks are, as crazy as this sounds, overvalued in comparison to growth stocks. I think people are ga-ga over dividends because bond yields are so low, and because people are expecting deflation, which punishes debt holders and rewards savers (of dividends), and because people think Obama won't dare raise the tax on them. I think back to when I first started investing in the late nineties. I think I was drawn to "value" and dividends not because of an inherent conservative streak (though I'm not exactly Keith Olbermann), but because non-dividend-paying stocks, "growth" stocks, were at the time so untethered from reality that I viewed them as nonsensical, and this shaped my fundamental investing worldview. I think the pendulum has swung somewhat. We are now in a time when people DON'T want to take risks. Hedgies helped bid us up in 2009. But really everyone is hunkering down in utilities and stocks like MO, sucking their thumbs, and/or betting on gold. Well, maybe that means its time to take a few risks of a different sort? I'm not sure. As I said, it's an experiment.

Prospects for Growth: Many U.S. hospitals that have only have one of ISRG's machines, many hospitals have none, even more growth potential exists (potentially, potentially) outside of the United States, and finally, the company will continue to expand the types of procedures for which it can be used.

Valuation: As I said above, at $390/share, I was freaked. Frankly, I'm still freaked. I'm not putting my life savings in this one. But today ISRG trades at $283.74. That represents a PEG ratio of 1.1, which is not unreasonable at all. That represents more than $100/share (>25%) off the 52/week high. The P/E is 36.2, the forward P/E is however 'only' 27.3. But with this company you have to think about the growth and moat. I think it has tremendous growth opportunities as detailed above, and it has a moat that comes from large switching costs, and sunk costs, once hospitals have the devices and people are trained. Hospitals in my area actually advertise that they have it, as a way to get people to go there. Discounted cash flow shows that this stock is still fairly richly valued; you need to plug in some serious, serious growth assumptions (I'm talking 20%-plus growth rate for ten years, with 3% terminal growth, 10% discount rate) for a purchase to make basic financial sense. To have a real margin for error, you need BETTER than that. (Someone correct me if I'm wrong, I'm not a math guy.) But the thing is, I actually shock myself by thinking ISRG has a good shot at acheiving those growth rates, or more, maybe much more. That is, of course, an intuitive (moves pinky to mouth) feeling, rather than a scientific conclustion. But I just have a feeling, like this thing is AMZN in late 2003, when everyone thought it was a nosebleeder at $60/share. (AMZN, by the way, pretty much shoots to shhh my theory that growth stocks are out of favor right now...yowzers, what's going on there at $160/share?)

Financials: I will not invest in a growth company that has tons of debt. ISRG has none. The current ratio is an absurd 5.2 (2 is what I look for in a value pick). Returns on equity and investments are both above 15. Margins are more than solid. It recently bought back shares, which is a bit wierd, but shows management confidence, though it's part of a trend right now, too.

Insiders: The Chairman bought 1000 shares a few weeks ago. Very rare to see actual buying (as opposed to options exercises), though it may just be a confidence-building statement.

Major Risks: High litigation risk, new technology, so risk that future studies say it adds little value, eventual patent losses, high expectations for growth.

In short, I don't think this is a multibagger, at least in the near term. I do however think it could double in the next ten years, which is A-OK with me. I will consider buying more on weakness, so long as the weakness is naught but noise. In a double-dip it could go back to $150/share. If some hedge-fund manager sneezes it could go to $200/share. I recognize that. (I'm writing that, so that when it does, I won't sell the stock, I'll buy more.) Because the business is good.

Finally, I should add that although this probably sounds like a good pitch, and it may the longest pitch in the history of CAPS, I have a CAPS rating that stinks like Glenn Beck's armpits, so take everything I say with a few grains of salt.

May God be with me.

Report this Post 17 Replies
Member Avatar TheDumbMoney (43.71) Submitted: 10/1/2010 10:37:11 AM
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Perfect. So this morning Josh Peters has a video on saying he thinks dividend stocks are over-valued relative to the market. I would just like to point out I wrote this pitch last night, saying that, before that video showed up. I'm a huge fan of Josh Peters though, and the validation is nice.

Member Avatar TheDumbMoney (43.71) Submitted: 10/1/2010 10:47:49 AM
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Other things I also considered: India ETFs, various stocks coming up on my value screens (lots of drillers and oil/gas companies), AZZ, Vanguard's emerging markets ETF.

Member Avatar TheDumbMoney (43.71) Submitted: 10/1/2010 9:49:42 PM
Recs: 1

Let me give you some idea of what growth is: ISRG has grown 25% or more annually just about every year for the past ten years. Starting from an admittedly bad baseline of June 2009, it increased its year over year diluted earnings more than 85% last quarter. Net income (after taxes) increased over 92%, year over year. Gone are the torrid days of 2005 -- 2007, when ISRG doubled Free Cash Flow EVERY YEAR. But the ebb in FCF growth in 2008 was largely the result of some major capital expenditures (at a bad time -- ISRG, don't get into real estate) in new land for a building in Sunnyvalle, as well as IP purchases. That's in the 2008 annual report. Meanwhile FCF growth is now up again, seriously. We'll know more after the earnings call in late October, but FCF for the 6/2010 quarter nearly doubled FCF for the 6/2009 quarter (again, bad baseline). I want to emphasize again there is hinkiness in the cash flow statement, but the primary thing driving this growth is CLEARLY old-fashioned, rip-roarding revenue/net income growth.

As always, I have to say I'm not a professional, I get things wrong, and you should do your own research. I own all of the stocks I rate on CAPS.

Member Avatar AjarnMichael (31.87) Submitted: 10/5/2010 12:13:30 AM
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Good luck. Sounds like you put in ample research. Personally, I'd still wait and see if it drops below $200 before getting in. Like you, though, I'm no professional and my hunches are certainly no more likely to be accurate than yours.

Member Avatar TheDumbMoney (43.71) Submitted: 10/21/2010 11:40:22 AM
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Okeydokey, 10-Q is out. My take:

-- Quarterly gross profit up a tad over 25%, year-over-year: good, not great, on target.
-- Net income up 34.26%, year-over-year: great, I think. Net income is gross profit minus all expenses and minus tax liabilities. The fact that net income grew so much more than gross profit speaks to me of increasing efficiency, since it does not in this case result from a giant reduction in tax liability. One can tell a different story, what one may currently call "The WalMart Story," in which efficiencies continue to be wrung out in lieu of an increase in gross profits, and treat that as a negative. But this story doesn't feel that way to me. This is a story of revenues going up, and that revenue growth being driven by product, not by sales, etc., expense growth.
-- Diluted EPS up 30.49&, year-over-year. Very good.
-- Cash flow. Only a nine-month timeframe is provided, so I will not show a percentage growth comparable to above, but for the nine months it was up 65.29%. Say what? A simple way to value cash flows is (Cash Flow from Operating Activities) plus or minus (Cash Flow from Investing Activities) plus or minus (Cash Flow from Financing Activities) = Cash Flow. You calculate growth by doing a simple percentage growth from the prior period. Here as I highlighted before are some things I am not wild about. First, operating activity cash flow was up an even 50% in the last nine month period....great, but a sizeable chuck of this is coming from questionable sources, mainly as an result of stock based compensation (compare the 56.3 million debit in operating cash flow to the 56.3 million credit in cash flow from financing). Additionally, there was a lot of net stock issuance that impacted cash flows from financing, not a fan. Cash flows from investments were a big negative; I *think* still mainly relating to the purchase of land going back to 2008, but I may be wrong about that -- remind myself to check the next annual report. In short, cash flow growth is not presently sustainable, and is not fully tethered to organic growth in revenue, gross profit, and net income. On the other hand, my buy-assumption does not assume 65% cash flow growth. Growth even of the base of gross profit essentially justifies my buy-assumption. HOWEVER, year-over-year revenue growth was only 22.95%. That does NOT justify my buy assumption.

Conclusion: I remain cautiously optimistic. I understand why the stock dropped on the quarterly report, however. Mainly, revenue growth is a bit disappointing. Increasing efficiency leading to higher percentage gross profit growth and higher net income growth is great, but ultimately with a growth company like ISRG one wants baseline revenues to be going up, up, up -- increasing efficiency only takes one so far, comparable to trying to balance the federal budget by cutting spending, excluding medicare/medicaid and social security, it only takes you so far, and it ain't ultimately far. I will continue to hold the stock, but I will look closely at the next annual report. I could also at some point stand to do further research on the revenue picture: two factors that may be at play: 1) offer to exchange S systems for Si systems may have temporarily depressed revenue, but in a loss-leader way that ultimately leads to more service-based revenue; 2) deferred revenue may be depressing the numbers.

Until later.

Here is the 10-Q link.

Member Avatar TheDumbMoney (43.71) Submitted: 12/13/2010 12:10:31 PM
Recs: 0

It is down to $255.45 today and I added incrementally at that level, since it is 10% below my initial buy-in. I will add more if it hits $230/share.

Member Avatar TheDumbMoney (43.71) Submitted: 12/29/2010 4:51:03 PM
Recs: 0

Well, it's clear I got in a bit too early. Price has stabilized around $260/share, hopefully does not go too much lower. I still very much believe in the company.

Member Avatar TheDumbMoney (43.71) Submitted: 1/14/2011 1:22:58 PM
Recs: 1

This pretty much rocks:

I'm anxiously awaiting the 1/20/2011 conference call....

Member Avatar TheDumbMoney (43.71) Submitted: 1/20/2011 6:55:18 PM
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Excellent earnings report after the bell today, see here:

My very quick take: A year-over-year increase in revenue of 34% was very powerful, and resolved some of the revenue uncertainty about the prior quarter's revenue results. That is in my view what is pushing the stock up $33/share in after-hours trading (we'll see if that actually holds tomorrow though). Additionally, net income grew powerfully, and EPS grew powerfully, as did cash on hand. The company is functioning very well, particularly since hospitals are still likely financially strapped. What are some negatives? -- systems revenue was only up 10% versus the fourth quarter of 2009. That's not great in my book, but it may reflect continuing spending sensitivity. Overall procedures done using da Vinci were up 35%, which is powerful growth, shows there is nothing wrong with the business model and the product. (I.e., right now it makes more sense for hospitals to more fully utilize existing da Vincis than to buy more.) With that kind of procedure growth, more systems growth seems likely to follow. And in any event, the company grew earnings per *diluted* share from $5.93/share in 2009 to $9.47/share in 2010. Um, in case you don't have a calculator handy, that's nearly 60% growth (though starting from a bad baseline, to be sure).

Conclusion: I'm pleased. I'll hold whether or not the aftermarket gains hold up tomorrow. As always when things go well, I wish I had bought more. The only number I haven't seen is the 2010 FCF number, but I suspect that's better as well.

Member Avatar griderX (96.13) Submitted: 1/24/2011 1:50:26 PM
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Regarding the Skills Simulator: Very cool concept....can you imagine at least one of these machines in every medical/surgical school in the US! This is truly new market for ISRG! There are about 130-160 Medical Schools in the US alone...imagine multiple units in Universities! Perhaps near 1000+ worldwide!

Member Avatar TheDumbMoney (43.71) Submitted: 2/4/2011 6:30:35 PM
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True, though I actually suggest you think bigger. I believe their goal is for hospitals to use these training machines as well, or certainly some of the larger hospitals. I don't think they are primarily targeting medical schools. I'm guessing ISRG's ten-year goal is to have multiple da vinci's in every hospital, doing vastly more procedures than they do now, with these training machines additionally in medical schools and additionally in many major hospitals (also facilitating growth in procedures), in addition to having major inroads of sales of da vinci's in the non-U.S market. There are a lot more hospitals than there are medical schools.

Member Avatar TheDumbMoney (43.71) Submitted: 7/18/2011 12:18:04 AM
Recs: 0

Doubling holding today at approximately $368/share. I wish I had bought more previously, but I've recently read-me-some Phillip Fisher. I am trying to move away a bit from pure value. A couple of his tenets are that you shouldn't avoid buying a company just because it has gone up in price, and that you should trust great companies to grow, even when the P/E is high. Well here even after the appreciation the PEG is 1.3. I think this company is just going to ramp up and up and up in terms of procedures done (types of), and in terms of international growth, which is still really nascent. The big risk is that robotic surgery turns out to be less beneficial than it currently seems. I will be monitoring that. In the meantime, this is my favorite 'growth' stock in the world. Other 'growth' stocks I favor are on my "Watchlist," which is vastly outperforming my actual CAPS and RL holdings.

Member Avatar TheDumbMoney (43.71) Submitted: 7/18/2011 12:20:05 AM
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Whoops, looks like it will be around $358, not $368.

Member Avatar Frankydontfailme (27.30) Submitted: 7/29/2011 5:20:34 PM
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This one of those companies, that when the market truly bottoms, I would invest heavily in without blinking

Member Avatar TheDumbMoney (43.71) Submitted: 2/16/2012 6:05:59 PM
Recs: 0

At $507/share, I think we can all agree the appraised price is probably a bit ahead of itself. No plans to sell, though I expect to see this hit $450 again within the next year. Time will tell.

Member Avatar TheDumbMoney2 (98.59) Submitted: 5/16/2012 2:40:45 PM
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Sold 1/2 of holding, 2 shares, today at $536.12, with a $6.95 commission. Because this is in my IRA there are no tax consequences. This is per my own recent analysis that the stock is likely somewhat overvalued, combined with bad technicals. I will consider another add later. If this were in a non-tax-exempt account I would probably let it ride through the likely oncoming slump.

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