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On Health IT, Fools Go With the Hot Hand

Dana is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Last time we checked in on the health IT sector, it was on fire.

Some $19.2 billion in federal stimulus dollars were headed the sector's way, to be doled out based on completion of “meaningful use” requirements then being written by a committee of government and industry bureaucrats.

But writing and meeting requirements is one thing. Delivering value is something else. This has suddenly dawned on the industry, leading to a popular new hash tag called #EHRBacklash. It means people are dissatisfied with their Electronic Health Records bought with that sweet, sweet stimulus cash. 

You might think this means you should toss out all your health IT stocks. That would be unwise. What's actually happening is that a diffuse industry is recognizing an ongoing shakeout. Having bought software based on promises, nearly a third are now seriously thinking of switching providers. 

That's important, because while hospitals got government aid to buy, they're going to be switching on their own dime.

Some Losers

Some investors have already noticed what has been going on. They have bailed on companies like Quality Systems (NASDAQ: QSII), which has been trying to piece together a working solution by buying other companies. Playing charting games with a company whose products are annoying their customers is a bad thing. A more fundamental analysis is called for. 

I have written before about another loser, Allscripts (NASDAQ: MDRX). This was originally a software-as-a-service stack whose CEO, Glen Tullman, was close to the Obama Administration. Then they bought a company called Misys, and while that firm's CEO is now heading up Computer Sciences, a huge government contractor, what he apparently left behind was a mess. 

Some Winners

On the other hand, there are some winners in this space, and it may not be too late to profit on them.

I don't usually look kindly to companies whose shares are up 157% in a year, but when an industry is shaking out it's actually an indication that you have game. Meridata (NASDAQ: MDSO), which went public in 2009, has game.

Meridata, like Allscripts, offers software as a service. The difference is that Meridata's stuff works, and its Meridata Rave platform indicates electronic data capture with clinical data management. It's focused on clinical trials, not bedside performance, so many of the problems that apply to a hospital system, like connecting with payment systems, don't apply here.

The best plays, of course, turn out to be the old-line medical information experts, Cerner (NASDAQ: CERN) and McKesson (NYSE: MCK). While companies from Microsoft and Google to Hewlett-Packard and GE threatened to take over the space a few years ago, these companies simply stuck to their knitting. They had the industry contacts needed to win the big contracts, and they haven't annoyed the customers so badly that they're thinking of switching away.

The result is that over the last year CERN is up 17% and MCK is up 28.6%. Best of all both companies have been racking up these kinds of gains for almost four years now.

The Lesson

It turns out that health IT is not like other areas of computing. It has more of the dynamics of a government market, because hospitals and clinics are tightly regulated. That means there's a long, bureaucratic sales process and, more important, a lot of after-the-sale hand-holding necessary to get things working right.

When seen from a speeds-and-feeds basis, it seemed to me in 2009 that the old-line companies would find it difficult to compete with more mainline hardware and software suppliers. I was wrong in that assumption. Think of these more as defense suppliers and you start to see the picture more clearly.

It was a lesson to me, but you can now take this lesson and profit.  

DanaFBlankenhorn has no position in any stocks mentioned. The Motley Fool recommends McKesson and Quality Systems. Try any of our Foolish newsletter services free for 30 days. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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