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Why the Cochlear Limited share price is heading to a record high today

The Cochlear Limited (ASX: COH) share price is nearing a record high of $145.01 today after the hearing implant manufacturer updated analysts as to its operating performance and strategic goals at an investor day held last week.

On the analyst day the company reconfirmed its earnings guidance for investors to expect a full year net profit between $210 million to $225 million, which would be up 10% to 20% on the prior year. The guidance was re-affirmed despite the recent news that Chinese government tenders were expected to be below FY 2016’s levels in a result that was not factored into the original guidance.

Cochlear stock is now up 18% in 2017, 29% over the past year, and 145% over the past three years as the company continues to grow revenues, profits, and dividends thanks to the competitive advantages its market-leading technology creates.

As such I have suggested multiple times over the past 12-36 months that it’s a business growth-focused ASX investors should look to own. Over the period it’s also enjoyed the powerful tailwind of a falling Australian dollar as the majority of its revenues and profits are earned overseas.

Current guidance is based on an AUD / USD FX rate of 75 cents, which looks about right, although into FY 2018 there’s a small chance it may benefit from an even weaker Australian dollar.

Still investors should never make medium-term investment decisions based on the unpredictable outlook for currency markets, as it’s the underlying business quality that should always be the primary focus. On this front Cochlear ticks the boxes thanks to the market-leading quality of its “Cochlear implant” business for new patients across huge addressable markets.

Notably, its “services” business (that offers sound processor upgrades and accessories to existing patients) now also represents around 25% of revenues and offers big potential to compound the company’s growth over the long term.

Risks

Of course the business does face plenty of cut-price competition and is vulnerable to cutbacks in government sector health spending, although over the long term public healthcare spending is set to remain on an upward trajectory.

It also faces other manufacturing and operational risks as shown a few years ago when it was forced to recall one of its flagship products in a profit-hurting mishap that nevertheless failed to damage its strong reputation.

Valuation

Probably the only box it doesn’t tick for now as an investment is valuation, with the stock trading on 37x annualised earnings per share of $3.88. This is expensive and means the stock is ‘priced to perfection’ in that the market is expecting several more years of strong growth ahead, otherwise the share price is likely to come tumbling down.

I would rate the stock as a hold for now, but like others will be keen to buy if it does come back in price around 10% or so between now and it reporting its full year results in August 2017.

Another high-quality healthcare stock for investors to consider on a better valuation is Ramsay Health Care Limited (ASX: RHC). It has probably less earnings certainty than Cochlear due to its reliance on the private health insurance industry, but that looks adequately reflected in its current valuation around $70.60.

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Motley Fool contributor Tom Richardson owns shares of Cochlear Ltd. and Ramsay Health Care Limited.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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