Investors are going crazy for shares in hearing implant provider Cochlear Limited (ASX: COH), pushing the company's share price up 21% so far in 2016.
So what's all the fuss about?
Part of the appeal is undoubtedly the growing recognition that healthcare stocks have been a great way to earn returns above the bank laden S&P/ASX 200 (Index: ^AXJO) (ASX: XJO).
Cochlear is included in the strong performing S&P/ASX 200 Health Care Index (Index: ASX: XHJ) along with CSL Limited (ASX: CSL) and Fisher & Paykel Healthcare Corp Ltd (ASX: FPH), which have also been exceptional performers over 2016.
But the real attraction is the business itself. By its own estimates Cochlear is the global leader in implantable hearing solutions and is insulated from competition by a "comprehensive" portfolio of patents.
Enviable returns
Not only is the company growing sales revenue consistently, but the margins it can derive off its products are enviable. In the 2015 financial year Cochlear's net profit margin was 15.7%, but the company also achieved a massive return on equity (ROE) of 41%.
Return on equity is essential for investors. It divides net income by shareholder equity and reflects the return the company generates on shareholder funds. If sustainable, high returns can be invested back into the company to be compounded for years to come.
Cochlear's ROE was up considerably from 2014 when net profit was hit by higher costs and a provision for a patent dispute. By comparison, fellow heath care index company Ansell Limited (ASX: ANN) reported a ROE of 16%.
Cochlear's capital structure does include a fair amount of debt to push this figure up, with a debt-to-equity ratio of around 1.4x, but this is similar to CSL Limited and seems appropriate for the company's strong competitive position.
Should you join the party?
With a current trailing price-to-earnings ratio of 38, compared to the Health Care Index's 23.3, investors are certainly pricing in a lot of optimism.
However, Cochlear is expecting sustained long-term growth and certainly has a lot of attractive characteristics. Not only does the company help to massively improve patients' quality of life, but it is globally diverse and produces huge returns for investors.
If the high returns can be maintained and the company has stringent product quality focus, Cochlear in my view has the potential to continue to compound and deliver value for investors in the years ahead.
