Up nearly 24% year-to-date, the iShares US Medical Devices ETF (NYSEArca: IHI), the largest ETF dedicated to medical device manufacturers, is continuing its run of being on the of the best-performing healthcare ETFs over the past several years. However, some market observers believe valuations on medical device stocks are getting a little too rich.
Industry observers argue that medical technology companies can tap into increased healthcare spending among emerging economies while the U.S. market has matured and could experience slower growth. Looking ahead, in the years through 2024, spending growth is projected to average 5.8% and peak at 6.3% in 2020.
“The overarching health care narrative is logical. Healthcare is typically less correlated to the general economy and has, and will likely continue to, see high top-line growth due to the aging U.S population,” according to Seeking Alpha.
The $4 billion IHI, which holds over 50 stocks, currently has a price-to-earnings ratio of nearly 43x, implying a rich valuation relative to the broader market and the healthcare sector.
With “valuations above 50X for most of IHI’s holdings, growth expectations are much higher than reasonable,” reports Seeking Alpha.
Talking Tariff Vulnerability
IHI also has some tariff vulnerability.
“For the overall MedTech space, I think it’s going to be manageable,” RBC Capital Markets analyst Brandon Henry told Barron’s on Friday morning. “In a note out a couple of months ago, Henry considered the possible disruptions to the sector, which relies on Mexico for 15% of its imports and 7% of its exports.”
There is also some risk in the form of medical device industry fundamentals not supporting the rich valuations currently assigned to some of IHI’s marquee holdings.
“Medical device valuations are not supported by the fundamentals. That is not to say IHI will necessarily come falling down soon, but it is to say IHI and medical device investors may want to take their considerable profits,” according to Seeking Alpha.
By most reasonable metrics, about three-quarters of IHI’s holdings are trading well above historical valuations, but some may lack the ability to grow earnings fast enough to warrant those frothy valuations.
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