Quality Systems Inc - A Total Return Story on Sale

By Chuck Carnevale - June 6, 2012 | Tickers: QSII | 0 Comments

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I consider myself an investor in contrast to a speculator.  Consequently, I focus first on the business I am interested in before I even look at the stock price. Because no matter how attractively priced a publicly traded stock may appear, if I don’t like the business, I don’t like the stock.  For me to consider a company a great business, it must possess a proven record of consistent above-average growth.  The faster the growth, and the more consistently it is achieved, the better I like it.

In addition to growth, I also covet quality. One of my favorite quality considerations is debt, or more precisely stated, the lack of it. I go on the thesis that if a company has no debt it can’t go bankrupt. Even beyond that, I like to see solid fundamentals underpinning my companies. I call this my three little pigs investing philosophy, because my goal is to build a portfolio on bricks, not straw or sticks. And even though I like above-average growth, I never turn down a growing dividend where I can find one.

When I’m looking for growth, I screen for companies with historical track records of earnings growth of 15% to 20% or better. In truth and practicality, companies capable of generating that kind of growth are very rare. Moreover, to find one with an attractive and growing dividend yield is rarer still. Yet, there is one company that meets all the qualities I’ve discussed thus far, and best of all, I believe it is currently on sale.  The company is Quality Systems Inc. (NASDAQ: QSII), a leader in offering electronic health records to medical practices and hospitals throughout the United States.

Quality Systems – An Opportunity for Growth, Yield and Value

Since a picture is worth 1000 words, I would like to review Quality Systems through the lens of F.A.S.T. Graphs™, the fundamentals analyzer software tool.  Therefore, my first graphic plots Quality Systems’s earnings per share since calendar year 1998, multiplied by the company’s annual EPS growth rate of 29.1%.  When looked at void of stock price, we see a picture of a very consistent and fast growing business, and by looking to the right of the graph we also see that the company has no debt.

With my second graphic I introduce dividend income which is designated by the light blue shaded area on the graph.  There are two important takeaways that can be gleaned from the following picture. First of all, we see that the company paid its first dividend in calendar year 2004 (fiscal year 2005).  Second, we see that the company started out paying dividends very generously and has continued to reward shareholders with a growing dividend since fiscal year 2005.

Thus far, I see a company with a great significantly above-average operating history, no debt and what seems to be a very generous attitude toward shareholders.  Therefore, this looks to be precisely the kind of company that I described in my introductory remarks.

Now that I have identified this terrific looking little business with strong growth and a nice above-average dividend yield, let’s introduce price into the equation.  The following F.A.S.T. Graphs™ overlays monthly closing stock prices with earnings revealing a remarkable correlation between the two. Clearly, stock price has closely tracked earnings since calendar year 1998. However, even more importantly than the strong correlation of price-to-earnings, we also see a vivid expression of valuation.

The orange earnings justified valuation line (PEG ratio PE of 29.1) represents fair value, or what I call True Worth™.  Simply stated, when the black price line is above the orange earnings line the market is over valuing the company, when the price is touching the earnings line fair value exists, and finally, when the black price line is below the earnings line, as it is today, the company is undervalued. From a historical perspective, the following graphic clearly confirms my thesis.

When I examine the track record of this “quality” company, no pun intended, I discover how profitable its exceptional operating history has been.  This fast-growing entity with an above-average dividend yield has lavishly rewarded its shareholders far in excess of its appropriate benchmark the Russell 1000 Growth with Dividends. Keep in mind this is even considering that it is trading at one of the lowest valuations in its recent history.

Quality Systems -- The Future

Now that Quality Systems and its remarkable track record have piqued my interest, it’s time to turn to the future.  Because as we all can agree, although we can admire the past, we can only invest for the future.  Furthermore, even though historical price action is closely correlated to historical earnings, it’s the future earnings that we must buy as prospective investors.

The following F.A.S.T. Graphs™ Estimated Earnings and Return Calculator is based on the consensus of 19 analysts reporting to Capital IQ, a Standard & Poor’s company, estimating Quality Systems’ fiscal 2013’s earnings followed by a five-year forecast growth rate. From this perspective, analysts are expecting earnings growth to slow down to 19%, but to remain at significantly above-average levels.  However, at its current valuation the company appears to be fairly valued even at this slower rate of expected growth.

Also, management in their most recent earnings release has guided that they expect revenues to increase 20% to 24% and earnings growth to continue growing at 20% to 25%. Consequently, the consensus of analyst estimates appears reasonable and even slightly lower than company guidance. To me, this all adds up to a very intriguing long-term investment opportunity offering above-average growth with an above-average and growing dividend yield as a kicker.

My Thesis for Growth

Quality Systems develops and provides electronic health records and dental records for dental and medical practices as well as hospitals of all sizes throughout the United States. Their Nextgen division, which provides proprietary electronic medical records software and practice management systems, is by far their largest representing approximately 83% of total sales.  Inpatient Solutions represents approximately 11%, followed by Dental at approximately 4% of total sales, and their smallest division practice solutions at 2% of sales.

I believe there are several factors that should contribute to continued strong and above-average earnings growth for Quality Systems. First of all, our aging population requires more and more healthcare which generates a growing need for better record-keeping. Therefore, more and more healthcare entities are recognizing and implementing electronic health record keeping solutions.  However, penetration remains low at only 20% of physicians and approximately the same percentage for hospitals nationwide.  In addition to the United States, there is also a large untapped opportunity internationally.

But perhaps the biggest opportunity for the biggest players, like Quality Systems, in this highly fragmented industry is Healthcare Reform.  The American Recovery and Reinvestment Act earmarked over $60 billion in incentive and grant money to promote electronic health record adoption. Although Stage I has been rather benign, Stage II and Stage III introduce meaningful use requirements under healthcare reform. Quality Systems feels that this will force consolidation among the over 370 vendors currently operating in this fragmented industry.  They see this as a large opportunity for larger players like themselves. However, it should be noted that there are bigger players than Quality Systems in the industry, which is a risk to be taken into consideration.

Furthermore, there is additional consolidation of physicians that are responding to healthcare reform and pay-for-performance reimbursement models.  These include hospitals, commercial insurance carriers, and large enterprise provider groups.  All these reforms and changes are expected to place greater emphasis on the need for the type of electronic record-keeping that Quality Systems offers.

Summary and Conclusions

Quality Systems develops and markets healthcare information systems in the U.S.  Based in Irvine, Calif., Quality Systems and its NextGen Healthcare subsidiary develop and market computer-based practice management, electronic health records and revenue cycle management applications as well as connectivity products and services for medical and dental group practices and small hospitals.

The company operates through four divisions: QSI Dental, NextGen, Inpatient Solutions, and Practice Solutions. The QSI Dental division develops, markets, and supports software suites for dental practices, and practice management software, which is designed to automate and streamline various administrative functions required for operating a medical or dental practice.

Both natural forces and government introduced healthcare reform is spotlighting the need for electronic health record adoption that Quality Systems excels at.  Current penetration rates are low and consolidation high which represents many acquisition opportunities for Quality Systems. Consequently, I believe that there remains a highly visible opportunity for above-average long-term growth consistent with current estimates.  Therefore, I believe that today’s low valuation represents a great opportunity to build a position in this high-quality growing company with an above-average dividend yield.

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