Medical Devices: A Closer Look

With all the chatter about health care reform coming out of Washington, now may be a great time to consider health care-related investments.

Most investors look to big pharmaceutical companies for health care exposure.  That was the old way of profiting from the medical arena.  While these stocks are usually considered blue chips, they face a toxic combination of competition from generic drug makers and their own empty new-drug pipelines.  Think about it: When was the last time Merck (MRK) or Pfizer (PFE) released a true blockbuster drug?  Answer: It’s been a while.

The medical device sector could be a better way to profit from changes in the health care industry.  We recently highlighted several biotech ETFs that might deliver nice returns for investors in a changing health care climate.  Today we’re looking at iShares Dow Jones US Medical Devices ETF (IHI).  IHI’s holdings include companies that many investors are probably familiar with already, such as Medtronic (MDT), Covidien (COV) and St. Jude Medical (STJ).

IHI held up relatively well during 2008 while the broader market was taken to task.  During the recent market rally, IHI has outperformed the S&P 500 by 5%.  Its holdings are well-diversified with Medtronic accounting for 10% and Thermo Fisher Scientific (TMO), the next largest holding at just over 7%.  IHI, which holds about 40 stocks, tracks the Dow Jones Select U.S. Medical Equipment Index and has an expense ratio of 0.48%.  Additional information can be found in the IHI overview on iShares website.

IHI currently trades at about 14x trailing earnings and in line with its net asset value.  Most of its holdings are well-run companies with solid balance sheets and strong cash flow.  As a fundamental play, IHI is poised to reap some nice rewards if the politicians get around to fixing health care.  But even if that doesn’t happen, an aging population will serve to buttress the fortunes of medical device makers.  Increased demand for in-home medical care will also spark medical equipment buying.

Another reason to be bullish on the medical device sector is the fact that industry followers have been calling for a wave of consolidation for some time now.  Just as there is constant speculation big pharmaceutical companies will pick off small biotech firms to bolster their pipelines, the same can be said of the medical device group.  Going forward, IHI has the look of a steady, consistent ETF with the ability to weather inevitable market downturns.