Could the Cochlear Ltd share price crack $200 in 2018?

At $189 Cochlear Limited (ASX: COH) is not going to smoke out the value investors trading at 49x annualised earnings per share of $3.86 with a trailing yield of 1.5%.

So what’s behind a share price rise of 41% over the past year and 10% in 2018? Profit multiples around 50x are usually reserved for sexy tech shares just tipping into profitability that are expected to grow profits at prodigious rates thanks to low starting bases, high gross profit margins, the compounding effect of recurring revenues and strong top-line growth.

Cochlear though is forecasting net profit growth of just 7%-12% in financial year 2018 and as a medical device business has to sell the same number of medical devices it did in the previous year just to breakeven on a top-line basis if you assume the same average selling price.

One factor supporting the share price is the growth of its ‘services’ business that generates recurring revenue and has a bright future as healthcare becomes more digitally connected.

The digital future is letting it upsell to patients and offer new products or digital services that generate recurring revenues on good profit margins. Services revenue was up 12% over the most recent half year and looks to offer consistent double-digit revenue growth into a future that could see it expand into any number of different digital services.

To digress slightly another leading medical device maker in ResMed Inc. (CHESS) (ASX: RMD) is worth brushing up on as it moves into the digitally connected (software powered) healthcare space in an attempt to lift profit margins and grow recurring revenue streams.

Another factor for Cochlear is that sales in its core developed markets remain reasonably strong with 12% growth over the most recent half. North America in particular remains important Cochlear is also likely to benefit from tax cuts in the US from January 2018. The valuation may not seem so high when you account for the bottom-line boosting effect tax cuts could have for many years to come.

Emerging market growth is lumpy as it is partly driven by its success in winning Chinese government tenders. Cochlear recently announced it is to spend $50 million building a manufacturing facility of Chengdu in China and this is not a coincidence, it is because the company wants to curry favour with the Chinese state among other factors.

There’s no doubt that underlying demand for Cochlear’s implants should remain strong whether privately or publicly funded.

Indeed as with a company like CSL Limited (ASX: CSL) it is in an excellent position as national governments worldwide could double their healthcare spending budgets tomorrow and there would still be loud calls and pressure for greater spending.

Finally Cochlear has a moat given the complexities of the hearing implant space which provides it pricing power.

As Charlie Munger and Warren Buffett as two of the world’s most successful investors have often said the best companies are those with these two qualities above nearly all others. That’s why Buffett has just bought heavily into Apple stock (have you ever seen an iPhone discounted?) and why he would probably like a business like Cochlear that doesn’t offer half-price hearing implants.

Evidently on the local share market not all growth or high PE stocks are created equal.

Some can disappoint and see huge share price falls as we’ve seen with IPH Ltd (ASX: IPH) recently. While others can disappoint like Cochlear but retain high multiples due to the market’s perception of their defensive qualities. That’s not to say that Cochlear shares could not come in for an almighty tumble later in the year for any number of reasons.

Still it would only need to add another 5% in value to be the first ASX listed business to crack $200 per share.

For now I’d suggest it’s a hold at best on valuation grounds. However, ASX investors should keep it at the top of their watch lists in the case of a significant share price sell off.

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Motley Fool contributor Tom Richardson owns shares of Cochlear Ltd., CSL Ltd., and ResMed Inc.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia owns shares of and has recommended IPH Ltd. 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 Scott Phillips.

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