Medical Devices Are The Quiet Growth Sector by Brandon Chicotsky

Summary

The medical device industry utilizes both low and advanced technology and often employs existing consumer products like smartphones. Thus, there is expanding utility and increasing demand for innovation.

An increasing retiring population has helped motivate injections of capital into the medical device industry while propelling demand for growth.

ETFs in the medical devices industry provide both diversification and high returns.

The role of medical devices in the practice of medicine is increasing. Many companies are working to improve medical care and reduce costs through innovative designs and product launches. In many cases, companies are working to provide physicians and nurses with the necessary tools to improve their performance and efficiency. Investor opportunities are attributed, in part, to a low barrier of entry for offering improvements to the existing marketplace of devices. There is demand for innovation and growth of technology, which benefits investors wary of more volatile segments like technology and healthcare.

Medical devices encompass a wide variety of products. Examples include a simple tongue depressor used in routine check-ups, knee replacements, and $1 million+ MRI machines found in exclusive hospitals. Medical practitioners have a reputation as highly scrutinous.

Nevertheless, the adoption of new medical devices continues to expand in both numbers and capabilities. As defined by the North American Industry Classification System (NAICS) and the U.S. Census Bureau, the medical device industry is a $140 billion industry in the United States, encompassing over 5,800 companies (80% of which have 50 or fewer employees) and employing 356,000 people.

Some devices can be deemed market-ready without a rigorous approval process. However, if a device “poses a significant risk of illness or injury,” it is classified as “Class III” by the Food and Drug Administration (FDA). A testing and approval process comparable to the one found in the pharmaceutical industry is required for Class III devices. The products sometimes must go through trials that take years. Similar to newly-patented medications, the company must charge a premium to recoup the cost of development and hopefully make a profit before becoming available to competitors.

The baby boom generation’s transition into Medicare has huge demand implications for these devices, and across the healthcare industry. In the United States, the over-65 age cohort now stands at 15% of the population and is expected to grow to 20% by 2030. Additionally, the percentage of the world’s population over 65 is predicted to rise from 8.5% to 17% by 2050.

Medical devices are also increasing the quality and efficiency of healthcare, and in many cases, commandeering common consumer devices to function as medical devices. Apps on smartphones and tablets now make it possible to access medical records, drug information, and research at a physician’s fingertips. Also, patients can now utilize these devices for the physician visit itself.

A company called Teladoc (TDOC) allows patients a virtual visit to the doctor at any time of the day utilizing a laptop or mobile device, as well as medical devices such as blood pressure monitors. In many cases, patients receive a diagnosis and a prescription from this service. Basic checkups cost as little as $40 versus costs often exceeding $130 for an in-person visit at a doctor’s office. Also, Internet of Things (IoT) products and services allow for more efficient patient monitoring by performing more tasks on lower-cost devices.

Finally, from an investment perspective, the medical device industry offers both stability and growth. Revenue streams tend to show stability, companies exhibit fewer issues with patents and FDA approvals, and firms tend to be smaller, although many large companies also exist in this industry.

Though not a pure medical device play, the name in medical devices that’s arguably most familiar to consumers is Johnson & Johnson (JNJ). While Johnson & Johnson is best-known for low-tech medical devices such as Band-Aids or cotton swabs, the company is also heavily involved in pharmaceuticals and advanced technology devices less familiar to consumers. Surgery rooms utilize Johnson & Johnson’s products for procedures such as knee replacements, laparoscopic procedures, and wound care.

Another medical device company that’s a favorite of investors and ETFs alike is Abbott Laboratories (ABT). Among Abbott’s specialty areas are medical devices for diagnostics, vascular, and diabetes care. Medtronic PLC (MDT) is another leader in the medical device industry. Medtronic manufactures numerous products involved in the practices such as general surgery, cardiac rhythm, cardiovascular, and spinal/orthopedic care.

While investors can gain a better knowledge of the industry by understanding individual stocks, exchange-traded fund (ETF) returns are such that investing in individual stocks is unnecessary to achieve returns higher than the S&P 500 average. Only two ETFs exist that are pure plays in the medical device industry, the iShares U.S. Medical Devices ETF (IHI) and the SPDR S&P Health Care Equipment ETF (XHE).

IHI focuses on investment results in the U.S. medical devices sector. Medtronic, Abbott, and Thermo Fisher Scientific (TMO) are its three largest holdings, though it holds positions in familiar names such as Boston Scientific Corp. (BSX) and Baxter International Inc. (BAX) as well. The fund returned positive results in every year since 2009. In most of those years, the returns registered in the double digits, although the 2016 return stood at 9.3%.

XHE takes a similar approach, concentrating on the S&P Healthcare Equipment Select Industry Index. Its main difference from IHI is its portfolio. XHE is more focused on smaller companies and smaller positions. Its top three investments are lesser-known companies such as OraSure Technologies, Inc. (OSUR), Insulet Corp. (PODD), and Nevro (NVRO).

However, these three companies combined account for only 9% of its holdings, compared with about 28% for IHI’s top three stocks. Due to its inception date of January 26, 2011, its track record is less lengthy than its iShares counterpart. However, the ETF yielded a double-digit return in every year of its existence, producing a return of 39.45% in 2013 and 11.78% in 2016.

The medical device industry offers investors the unique opportunity of profiting from technological advances while offering the profitability associated with lower-risk healthcare sectors. The medical device industry is large and diverse, encompassing all levels of technology and company size.

It is well-suited to capitalize on the aging baby boomer population as well as providing efficiencies that benefit both patients and medical professionals. Investors have numerous choices of individual stocks and can easily diversify into ETFs that have provided returns higher than the S&P 500 index. For a combination of high returns, lowered risk, and potentially large gains, the medical device industry is an option.