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Stock Strategist

Intuitive Surgical: Even the Widest Moat Can Be Overpriced

Avoid using a robotic approach when valuing these shares.

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We believe the market is overestimating  Intuitive Surgical's (ISRG) long-term revenue and earnings growth potential. Our valuation model and company report incorporate optimistic expectations for emerging procedures even as growth moderates in core procedures. But we also expect that post-reform, U.S. hospitals operating in a tight reimbursement environment will be increasingly motivated to maximize returns on their investments, which will be reflected in slowing growth of da Vinci system sales. While we don't think that the European spending environment will remain constrained permanently, we do believe Intuitive will generally face a tougher road ahead in Europe, where providers are more hesitant to adopt new-generation technology than their U.S. counterparts. We are cognizant that Intuitive has long been a Wall Street darling, and rightfully so, given the performance of its business and shares. However, we think the market continues to extrapolate past growth forward, as evidenced by the overwhelming bullish sentiment despite the 28 forward earnings multiple and tougher comps ahead. Our $420 fair value estimate implies a 23 multiple to our 2013 earnings per share forecast, and we believe the stock is currently moderately overvalued.

We have to separate our belief in the durability of the company's competitive advantages from our take on its valuation. In our opinion, Intuitive's wide economic moat continues to stand out as one of the most durable in the sector. The company probably won't be enjoying its monopolistic position for much longer, as we estimate competitive platforms to enter the market in 2016-17, but we don't believe Intuitive will cede meaningful market share, given its plethora of clinical data and massive installed base. Enormous switching costs and a meaningful recurring revenue stream shield the firm's position and its returns on invested capital. We forecast adjusted ROICs in the 50%-plus range throughout the decade.

Alex Morozov does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.