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A doctor holds artificial hip joints Friday, Jan. 20, 2006, at Rush University Medical Center in Chicago. (CHARLES REX ARBOGAST/AP)
A doctor holds artificial hip joints Friday, Jan. 20, 2006, at Rush University Medical Center in Chicago. (CHARLES REX ARBOGAST/AP)

NUMBER CRUNCHER

Medical device stocks: Braced for an aging population Add to ...

Mr. Bowman is a portfolio manager at Hamilton-based Wickham Investment Counsel Inc., an adviser to high-net-worth clients. mike@mikebowmangroup.com

What are we looking for?

One in 20 Americans older than 50 is walking around with an artificial knee, according to the American Academy of Orthopaedic Surgeons.

Since the operations are increasingly performed on younger people, and since these devices do wear out, many will live long enough to need a second and maybe a third knee replacement. My colleague Rob Belanger and I decided to take a walk through the North American medical device sector.

The screen

We started with North American companies larger than $1-billion (U.S.) in market capitalization.

Price-to-cash flow (P/CF) is a valuation ratio. A low ratio may indicate an undervalued company while a higher ratio may point to an overvalued company. Only companies with a P/CF under 20 are included in our screen.

Enterprise value divided by earnings before interest, taxes, depreciation and amortization (EV/EBITDA) is one of the most commonly used valuation metrics. We seek a low number.

Sales growth for the current year had to be positive compared with the previous year.

Operating margin is a measurement of what proportion of a company’s revenue is left over after paying for variable costs of production. Our screen only shows companies that had an operating margin greater than 10 per cent and we sorted them from the highest to the lowest.

Return on equity (ROE) measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested. A high number is ideal, and only companies with an ROE over 8 per cent made our screen.

We also added research and development costs as a percentage of sales.

What did we find?

Edwards Life Sciences developed the first commercially available heart valve in 1958 and today it is a world leader in valve production. The company leads our screen in the P/CF category.

The joint replacement technologies of Zimmer Holdings are available in more than 100 countries and the company ranks the best in our EV/EBITDA category.

Medtronic is a world leader in pacemakers and has the best operating margin of all the companies we screened.

Only one company performed better than the averages in all categories, and that was Johnson & Johnson.

You should contact an investment professional or conduct further research before adding any of these companies to your portfolio.

North American medical device sector

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