A Checklist for Medical Technology Investments

What Is the Medical Technology Industry?

The medical technology industry, commonly known as medtech, is made up of companies that develop, design, produce, and sell medical technologies, equipment, and health care information systems.

Its impact on the care and well-being of patients and the efficiency and effectiveness of providers has been, and continues to be, substantial.

Medtech offers investors substantial growth potential, strong returns on capital, government-enforced restrictions on competition, and products that can be essential to maintaining people’s quality of life.

At the same time, it has its challenges. Companies face major upfront development expenses, a high failure rate, a constant stream of would-be rivals and a federal regulatory body that enforces strict, and sometimes arbitrary, standards.

As of 2024, medtech was a $587 billion industry. Compound annual growth of revenue from late 2019 to the end of 2023 was 8.3%.

As with any investment, you should be sure to conduct your due diligence before investing. With that, here is a checklist of five pointers that may help your investment decision-making in the dynamic medical technology industry.

1. Look for an Innovator, Not a Follower

When considering a potential medical technology investment, it’s generally better to look for a company dedicated to new technologies and innovation.

Take Note of R&D and New Products

New products typically offer better performance (better outcomes for the patient, easier for the doctor to use and so on). Such improvements typically command a premium price and drive market-share shifts to the new product.

The best way to assess whether a given company is focused on innovation is to look at the company’s product pipeline and research and development (R&D) efforts.

Small companies are generally upfront about their projects currently underway (often it’s the only thing management has to talk about with investors).

However, large companies don’t often disclose much information of this type. In those cases, try this rule of thumb: If a company is spending less than 10% of its revenue on R&D, be suspicious.

2. Don’t Sweat the Details

Expert medical knowledge isn’t required for medtech investing. In fact, even the smartest medical minds have a mixed record when it comes to seeing the future of medical technologies.

So investors should never feel intimidated by a medical expert’s potentially complicated or obscure take on a given stock or therapy.

It is certainly worthwhile to read up on the conditions that a company’s products are intended to treat. Go online to find a wealth of information on almost every medical condition that constitutes a viable market opportunity.

From peer-reviewed journal papers to individual patient blogs, any investor can get a sense of the driving factors in the treatment of any medical condition.

3. Understand the Life Cycle

There are several key points in a medtech company’s life cycle, and each stage has certain ramifications for an investor.

1. Startup companies often face years of losses and cash outflows as management tries to lead new products through clinical trials and regulators, and onto the market.

The amount of cash on the balance sheet, the efficacy of the product, and the candor of the management team are crucial. Assuming that the clinical data is positive, the company will eventually face the FDA and the thumbs-up/thumbs-down decision that follows.

2. If a company secures FDA approval, the next stage is the marketing launch and sales ramp. At this stage, it is critical for the company to have a solid marketing team in place. Look for strong initial sales growth, but don’t expect profits just yet.

3. Once a company achieves profitability, the game changes. Simply put, very few medtech companies ever mature into large, independent players.

For the most part, companies are acquired or turn to buying companies themselves. That means investors should keep an eye on deals and take note of companies that overpay in their attempts to grow through acquisitions.

4. For those companies that do establish themselves as large, independent players, this stage is a continuous process of managing the existing business, introducing new products, and shepherding the growth of shareholder value.

4. Watch for Government Actions

If there is a risk factor to medical technology that’s not common to other companies, it is the significant potential impact of the U.S. government on businesses in this industry.

FDA Approval

The Food and Drug Administration (FDA) effectively determines whether a company can do business in the U.S. Before a device can be sold legally, the FDA has to approve its sale.

While not all product approvals require expensive clinical trials, most of the products that drive significant revenue growth for the industry do require substantial data on efficacy and safety before the FDA permits their sale.

FDA Monitoring

In addition, the FDA requires ongoing monitoring and reporting and can order devices off the market if hidden dangers reveal themselves in subsequent years.

The FDA has a mandate to protect the safety of the general public, but the proper tradeoff between the risk and reward of a new device or therapy is subjective.

Complicating matters, the attitude of the FDA regarding that tradeoff seems to ebb and flow over time.

Investors can minimize the risks to their portfolio by choosing companies that either have a suite of approved products already on the market or that have very strong data for products under development.

Influencing Payment

The government also plays a role in determining if medical technology companies get paid for their devices and therapies.

Medicare is a major factor when it comes to how Americans pay for their health care. If the government pulls back on how much it’s willing to pay for various therapies or devices, that can affect the sector.

In fact, private insurers will often take a cue from Medicare when they form their own coverage policies.

5. Accept a Different Valuation Standard

The valuation standards in medical technology are a little different from those in other industries. If you look at many of the bellwether medical technology stocks, such as Alcon (ACL), Stryker (SYK), Boston Scientific (BSX) and Medtronic (MDT), you will see historical ratios above (and sometimes well above) the prevailing S&P 500 Index levels. These ratios include:

Over time, medtech stocks have generally outperformed the S&P 500 and held up relatively well in periods of difficult broader-market performance.

There are arguments in favor of more-robust valuations; this industry sports above-average margins and return on invested capital, doesn’t fear generic competitors, and offers products with pretty inelastic demand. After all, a person may be able to delay buying a new car or TV until the economy gets better, but they can’t delay treating a heart attack or broken hip.

Investors new to medical technology should also realize that, for better or worse, the price-to-sales ratio is a commonly used metric for these stocks (particularly at the small-cap and mid-cap levels).

In fact, emerging medtech stocks trading below a price-to-sales ratio of 4 may be regarded as a buy, and those trading above 8 or so may be regarded as overpriced or at least overheated.

The Bottom Line

Medical technology is a dynamic industry, with new technologies and products emerging virtually every year. Some investors avoid it because they believe that it’s too complicated to understand.

It may take some time and effort to get up to speed on medical technology companies and their stocks. But if an investor methodically researches and assesses the overall industry and individual medtech stocks, they can then decide with confidence whether medtech is a good fit for their portfolios.