XHE - IHI: High Valuation But Growing Healthcare Play

2024-01-02 14:30:37 ET

Summary

• Investing in medical device stocks can be a compelling option due to the growing industry, high demand, and technological advancements.
• The iShares U.S. Medical Devices ETF provides broad exposure to the U.S. medical devices sector and has top holdings in Abbott Laboratories, Intuitive Surgical, and Medtronic.
• While there are pros such as favorable demographics and growth opportunities, cons include heavy regulation and high valuation of the IHI ETF.

I've written before about the idea that Healthcare could be a big winning in 2024 as money potentially rotates out of Technology. Investing in medical device stocks can be a compelling option for several reasons:

1. Growing Industry: The medical device industry is experiencing rapid growth due to factors such as an aging population, increasing chronic diseases, and advancements in technology. This presents ample opportunities for companies to innovate and develop new medical devices.

2. High Demand: The demand for medical devices is consistently high, as they are essential tools used by healthcare professionals to diagnose, monitor, and treat patients. This stability in demand can provide a reliable revenue stream for medical device companies.

3. Technological Advancements: The medical device industry is constantly evolving with new technologies and innovations. Investments in companies at the forefront of these advancements can lead to substantial returns, as breakthrough products often capture significant market share.

4. Regulatory Environment: Medical devices are subject to strict regulations, ensuring safety and efficacy. While this can present challenges for companies, it also acts as a barrier to entry for potential competitors. Established companies with a strong track record of compliance and regulatory approvals are well-positioned to thrive in this environment.

5. Global Reach: The medical device market is not limited to a specific country or region. Many companies have a global presence and can benefit from growth opportunities in various markets. This diversification can provide stability and potential for growth regardless of economic conditions in a particular region.

6. Long-Term Investments: Medical devices are often considered long-term investments as they can generate consistent revenue streams over an extended period. This makes medical device stocks attractive to investors seeking stability and steady returns.

One way to play this rotation is through the iShares U.S. Medical Devices ETF ( IHI ), a leading fund in the medical devices sector. IHI, a passively managed exchange-traded fund ((ETF)), provides broad exposure to the U.S. medical devices sector. Established in May 2006, IHI tracks the Dow Jones U.S. Select Medical Equipment Index, which measures the performance of U.S. medical equipment stocks. With over $5.3 billion in assets, IHI is one of the largest ETFs in its sector. It carries an annual expense ratio of 0.40%, which is relatively low compared to other sector-specific ETFs.

IHI ETF Holdings: A Closer Look

IHI's portfolio consists of 54 holdings, with a significant concentration in the healthcare sector. The top holdings in IHI's portfolio include:

• Abbott Laboratories ( ABT ) : A leading name in healthcare, Abbott Laboratories makes up approximately 17.65% of IHI's total assets and is by far the largest holding.

• Intuitive Surgical, Inc. ( ISRG ) : Known for its revolutionary work in robotic-assisted surgery, ISRG forms a significant part of IHI's portfolio.

• Medtronic plc ( MDT ) : As a global leader in medical technology, services, and solutions, MDT is a key holding within IHI.

• Thermo Fisher Scientific Inc. ( TMO ) : This company, known for its scientific research services, is another major component of IHI.

• Stryker Corporation ( SYK ) : Specializing in medical technologies, SYK holds a significant position within the ETF.

These top five holdings account for nearly 50% of the ETF's total assets, indicating a high concentration of investments in these companies. You better like Abbot, Intuitive Surgical, and Medtronic if you want this fund in your portfolio.

Peer Comparison

While IHI stands out for its concentration in the medical devices sector, it's essential to compare its performance with other similar ETFs. For instance, the First Trust Indxx Global Medical Devices ETF ( MDEV ) and the SPDR S&P Health Care Equipment ETF ( XHE ) are other prominent ETFs in the same space. MDEV, with its focus on the INDXX GLOBAL MEDICAL EQUIPMENT INDEX, and XHE, tracking the S&P Health Care Equipment Select Industry Index, offer similar exposure to the medical devices sector. IHI has outperformed both over the last two years, and it's clear the weighting to Abbot helped a lot in that relative strength.

Pros and Cons of Investing in Medical Devices

Investing in the medical devices sector, and consequently in IHI, comes with its set of pros and cons.

Pros:

• The sector benefits from favorable demographics and increasing healthcare spending.
• The medical devices industry has high barriers to entry, ensuring less competition and greater pricing power for existing companies.
• The advent of new technologies and innovations in the healthcare sector presents growth opportunities for companies within this space.

Cons:

• The sector is heavily regulated, with changes in regulations potentially impacting the performance of companies.
• The valuation of IHI (a P/E of 40), coupled with its expense ratio, might be a deterrent for some investors.
• The performance of the ETF is heavily dependent on the performance of the healthcare sector, exposing it to sector-specific risks.

Conclusion

Investing in the iShares U.S. Medical Devices ETF provides exposure to a burgeoning sector with significant growth potential. While the ETF's high valuation and expense ratio may raise some concerns, its performance and the promising outlook of the medical devices sector make it an investment worth considering.

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