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2 Stocks to Buy, 2 to Sell in Medical Appliances

And as a bonus, here's what to do with sputtering Intuitive Surgical

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The 71-year-old CEO has been buying a lot of its stock lately, which has something to do with its meteoric rise. In addition, Opko has developed a high-accuracy a prostate test that’s ready for market. Given Frost’s understanding of pharmaceuticals, long-term I wouldn’t bet against him. However, he’s a billionaire and can afford to absorb losses indefinitely. You can’t.

OPK has come too far too fast with no real catalysts to drive it through $10. With a frothy $2 billion valuation (62 times sales), I’d expect its stock to tread water through the remainder of 2013. What happens after that is anyone’s guess, but it’s not for the faint of heart.

Sell #2: Hologic

Hologic (NASDAQ:HOLX) calls itself the “Women’s Health Company,” in part because of its 3D mammography imaging products. In the first quarter ended December 2012, its Breast Health segment saw a small increase in revenue to $220.8 million or 35% of its $631.4 million in overall revenue.

With the introduction of 3D systems, that percentage is likely to increase in the coming years. Hologic believes there are approximately 11,000 digital systems in the U.S. available for conversion to 3D. It expects to ship between 500 and 700 in the next two years. With 20% operating margins, the Breast Health segment is Hologic’s strongest business.

My concern with Hologic’s stock lies with its Diagnostics segment, which acquired San Diego-based Gen-Probe last year for $3.97 billion.

The acquisition added $3.5 billion in debt to a company that, only five years earlier, took on $1.7 billion in debt and the issuance of 132 million shares to acquire Cytyc Corporation for $6.2 billion. Two years later, it was forced to write off $2.3 billion in goodwill impairment.

In other words, it was a dud of a deal, and this one looks even worse, taking its debt-to-capitalization ratio from 33% before the acquisition to 63% after. Hologic hasn’t made good acquisitions in recent memory; both of these will come back to haunt them.

Morningstar gives it four stars, but I wouldn’t touch HOLX with a 10-foot pole. Even though it generates between $300 million to $400 million in free cash flow annually, it will take a good decade to pay down all its debt. And that’s not good when $2.5 billion of it is variable-rate interest.

And Intuitive?

Warren Buffett loves to see his favorite holdings drop in price because it allows him to pick up more. Intuitive Surgical is a great company that is growing free cash flow at a significant rate. If you own shares already, I’d applaud any pullbacks in its stock. If you don’t own any shares, buy some now and then some later if it drops some more.

If you don’t, you’ll be kicking yourself in five years when it’s a $1,000 stock.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

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